Tagged: BOE

Who are you going to believe?

Compare and contrast –

Last night’s Fed Minutes from the Jan 27-28 meeting:

‘Many participants indicated that their assessment of the balance of risks associated with the timing of the beginning of policy normalization had inclined them toward keeping the federal funds rate at its effective lower bound for a longer time.’

Fed’s Williams interview from February 11th:

‘Here is my concern. You wait so long that you get behind the curve and then you have to raise rates really rapidly and that creates a lot of market turmoil and maybe even potential damage to the economic recovery. I would rather go gradually, thoughtfully in adjusting policy than waiting too long and having to catch up.’

Who are you going to believe? Which side will Yellen take in her semi-annual testimony? John Williams is the Governor at the San Fran Fed, the spiritual home of one J Yellen…. Could Janet want to use next week’s testimony as her Carney-esque Mansion House moment?

Hands up if you’re not easing, Part… oh I’ve lost count

Sweden’s Riksbank have joined the easing party, announcing yesterday that not only have they cut interest rates into negative territory, to -0.10%, but also that they would indulge in a spot of QE. They left the door open to further rate cuts, and further QE – even at “short notice”(i.e. intra-meeting). The krona duly fell 2% against the dollar, equities hit a new high, and 10yr bond yields fell almost 10bps. So far, so what, you might say. We know this story now: “Deflation gripping the world, particularly Europe – hit that printing button!”. A 2% move in the SEK is not out of the ordinary, so it would seem the market is indeed becoming inured to all of this easing.

Let’s just take a step back for a second though. Sweden buying government bonds – is this the same Sweden that has a debt to GDP ratio of just under 40%, one of the lowest in Europe? The country where house prices barely dipped during the crisis and are now at record levels? (See chart below from the excellent interactive house price tool on the Economist website)

House prices

 

To be fair to the Riksbank, their lurch into QE is thus far only small – at 10bn SEK for a government bond market that’s about 1 trn in size, they’re not exactly “doing a Draghi”. Not yet, anyway. They did say they were looking into a Funding for Lending scheme, and lending 100bn SEK to banks over a four year period. So their intention to signal easing of policy is clear.

So the question remains, why did they do it? It’s that old chestnut, inflation again. Slightly strangely, the Riksbank barely altered their inflation forecasts:

Riksbank forecasts

 

But the fact is that inflation has been stubbornly below their 2% target for some time. Ever since the financial crisis, in fact, when core inflation spiked above 2% but has been declining ever since:

Sweden CPI

 

The difference between Sweden and the Eurozone is that in April 2010 the Riksbank began hiking rates, taking them up to 2% by the middle of the next year. Now, almost four years later, they still face a deflationary threat. They’ve been roundly criticised for hiking back then, and failing to cut quickly enough ever since. Will the criticism keep their pedal to the metal? Are they doomed to be forever fighting the last war?

This is relevant for the ongoing round of central bank easing because it could mean that they are cutting at the wrong part of the cycle. That would mean even more stimulus going into economies where it will ultimately feed through at the point when it’s least needed.

This is why the Fed’s recent work on the relevance of monetary policy lags is so important. Spot inflation is lower because of the collapse in the oil price, but as the BIS pointed out, the speed and depth of the decline is likely to be driven by financial liquidity rather than supply/demand fundamentals. Once that stabilises, so will inflation, and over time, given base effects, the hit to inflation will prove temporary.

Mark Carney seems to have been reading from the same manual as the Fed, with his opening remarks at the BOE Inflation (or should that be Deflation??) Report yesterday:

‘the effects of these large, one-off falls in prices [from commodity prices are] likely to dissipate in around a year, we will look through them.’

Central banks should be forward looking, and the most important part of the Inflation Report was not the incredulous headlines about the UK entering deflation, but the fact that the BOE now see the output gap at only 0.5%, down from the 1% estimate just three months ago. So half of the output gap is estimated to have closed in that period! Wages are going up, with the BOE forecast for unit labour costs up 0.5% pt in 2016 and 2017.

The point is – spot inflation may be lower, but you can’t ignore improving developments in the labour market. This is very reminiscent of Yellen’s December Fed statement, and we wait to see if she will reiterate this in her semi-annual testimony on February 24th. We may get a hint with the release of the January Fed Minutes next Thursday. When it comes to market pricing, the first Fed hike is priced by September of this year, while the BOE first hike is now around April of next year. The truth of the matter is that both may go somewhere in the middle of that period – enough time for the base effects from oil to fall out of the inflation data, and enough time for a tightening labour market to show signs of wage increases. Maybe don’t book a long Christmas holiday for 2015 just yet….you might miss all the action in December!

Oops they did it again…

Never let it be said that central banks are making up policy on the hoof… Here is a report this weekend from a Swiss newspaper that the SNB have a new plan for the Swiss Franc:

the paper said the SNB was operating “a kind of minimum exchange rate against the euro”…”The talk is of a ‘corridor’ from 1.05 francs to 1.10 francs

They go on to claim that a source suggested the SNB would incur losses of up to 10bn francs in its pursuit of this policy (Blondemoney hesitates to use that word).

Questions? Plenty:

1. The floor at 1.2000 didn’t work, why would a corridor?
2. Why wouldn’t EUR/CHF spend almost all its time at the bottom of the corridor, with it becoming a de facto floor?
3. The SNB defended the floor because it committed to “unlimited” intervention. Now it’s suggesting it’s only prepared to intervene up to a loss of 10bn CHF. How is that going to be more credible intervention?
4. How can a central bank admit that it is prepared to make such a loss?

So, it’s prepared to intervene less; to take a loss; and to try to keep EUR/CHF within a band.

If their credibility wasn’t already shot to pieces by the failure to maintain the 1.2000 floor, how is this going to restore it??

How is this going to stop people from thinking that perhaps in a few months time they decide they want a wider corridor? Or to manage the CHF against a basket of currencies, a la Singapore (which the SNB’s Danthine himself admitted “deserved closer examination”)? Or maybe let’s just run up a 10bn CHF loss and then decide?

Of course, there has been plenty of hedging activity from the locals since the floor disappeared, and perhaps this kind of leak is to entice them to jump in even more with their EUR/CHF buying, to act as a de facto stabiliser for the currency. But that’s just a short term solution.

Bigger picture, the central bank emperor’s new clothes are becoming ever more noticeable. Hark back to the words of the BOE’s Ben Broadbent from his speech in October last year:

 ‘Whatever does cause a sustained rise in real interest rates – a lasting solution to the arrangements of the euro area, perhaps , or renewed optimism about global productivity growth – it is unlikely to be the arbitrary whim of central bankers . Those betting on long-term movements in interest rates will have to work a little harder than just listening to people like me.’

The trouble is, the decline in inflation means we HAVE to listen to the central bankers, because they keep throwing in new easing surprises. Six months ago all the talk was of exit, but a fall in the (allegedly exogenous) oil price has thrown up the spectre of deflation, leaving central bankers no choice but to meddle. As the BOJ official said, the constant call for more easing derives from an obsession to avoid ‘Japanisation’ – whereas in fact the answer lies in structural reform.

This week we may see easing from Australia on Tuesday and from Turkey on Wednesday – the former due to a commodity-led growth slowdown and the latter due to political motivations. If we get both then the “any excuse to ease” policy is alive and well. Once again, Blondemoney hesitates to use the word ‘policy’ in this environment… at some point this year the market will stop being spoon fed by central banks and realise the positive element of all the recent monetary easing and disinflation shocks.

All change please, all change

Canada’s surprise 25bp interest rate cut yesterday is significant. Not just because it had a big impact on the markets, but also because it shows the shift that is taking place since OPEC’s decision not to increase production at the end of November. Two months is not a very long time in central banking terms, but the drop in oil since then has evidently been so large that even if it were to rebound, the price shift would still be regarded as persistent. The Bank of Canada input $60 oil into their economic models, and felt they had to take action, even if it were only “insurance“, as Governor Poloz described it. This is how they see its impact:

BOC Chart 10

 

That kind of terms of trade shock has to impact the currency – and a weaker currency would be of benefit to them, as they explained in their statement: ‘The negative impact of lower oil prices will gradually be mitigated by a stronger U.S. economy, a weaker Canadian dollar, and the Bank’s monetary policy response’. The Canadian dollar can fall a lot further from here.

It also raises questions for other petro-economies, like Norway. They don’t have a rate decision until the 19th March, but given the speed of Canada’s volte face (back in October they were only daring enough to remove their tightening bias), we may see something significant from the Norges Bank then. The Governor of the Central Bank and the Prime Minister met last week for the first time since the financial crisis to discuss stimulus measures. We may see increased rhetoric ahead of the meeting. The market is pricing a 25bp cut, but after that only another 40bps of cuts for the rest of the year. Blondemoney had thought that a significantly weaker NOK, post-Rouble crisis, might stay their hand, given core inflation is already running above their target at 2.4%… but Canada’s core inflation was also at their target, at 2%. The BOC Monetary Policy Report devotes plenty of time to why core inflation is so high, claiming its an unusual boost from ‘meat and communications’ (!):

BOC Chart 12

 

When a central bank starts talking about excess supply of cattle, you know the jig is up. They want to cut rates and they’ve found their argument. Here are their new CPI forecasts – the top line is core inflation, which remains similar to the levels from their October MPR, while the bottom line is headline inflation. I think we can see which one they are really worried about:

2015 inflation forecasts

Meanwhile the Bank of England were merrily having their own panic about the fall in inflation. In September CPI was 1.5%. By December it had fallen to 0.5%. Such a speedy drop indeed looks frightening. Enough that the hawks on the MPC cancelled their calls for rate hikes at January’s meeting, fearful they would be earmarked as the loons who wanted to raise rates into deflation.

And now today, the ECB are about to cross the rubicon. Quantitative Easing, allegedly incompatible with Article 123 of the Lisbon Treaty which prohibits monetary financing of governments, is about to be announced. Although the market claims this is all fully expected, and indeed that it won’t have any impact anyway, they are still short Euros and long Eurozone bonds in anticipation. You can see the signs of nervousness after the price action yesterday, following the headline around 2.40pm that the ECB were considering a bond-buying programme of “50bn EUR through 2016”. EUR/USD dropped 50 pts, then rallied a big figure, before settling back down to where it started:

EURUSD 21 Jan 2015 spike

All of this was apparently caused by Bloomberg running the headline as “through 2016”. In British English, that probably means “through until 2016”, i.e. only one year, whereas in American English it means “throughout”, i.e. two years. The difference in total size of the programme would be EUR 600bn, depending on the extra 12 months.

Again, when markets become this freaked out by semantics, you know today’s decision is a big deal. The market is rightly nervous because it is so hard to predict what the programme will look like. Blondemoney suspects until today the ECB didn’t know exactly what the final plan would look like either. Through his entire Presidency, Draghi has thought big, and when he has consensus, he acts big. If the market is disappointed today, he’ll throw more at it tomorrow. So the question is – what does it mean for the Euro? It’s not unambiguously negative, given that reflation should see inflows into European assets, unlike how a negative interest rate has a direct currency impact. It may be that they also announce a rate cut today – or keep that one in the locker if the Euro doesn’t perform how they would like. In the short-term, however, everyone seems to expect a short squeeze, and to sell on rallies. That usually means you don’t get much of a rally. We should see 1.14 before 1.18 today. Hold on to your hats.

 

Rates on hold forever

And so the worm has turned… even the hawks at the BOE have thrown in the towel with the “risk of low inflation becoming more persistent”, leading to a unanimous 9-0 vote to do nothing with interest rates. These minutes were all about inflation, and nothing else, whereas previously the Minutes have been devoted to trying to understand how much slack was in the labour market. The hawks shifted their vote because although they still think this fall in inflation could be a blip, and wages are indeed going up, they were worried that a rate hike might tip the balance for inflation back down again.

Is it any wonder that the market is spooked by lower inflation, when the central bankers clearly are?

Watch out this afternoon for the Bank of Canada – core inflation is running near target but of course the economy will be severely impacted by the oil price fall. If they switch to an easing bias, then the Canadian dollar will get beaten up even further, and expect other petro-currencies like the NOK to follow suit.

In the midst of what appears to be a central bank panic about the ghost of deflation, will the Fed stay firm? If so, then the dollar is going to the moon….

—– Key sections of the BOE Minutes below ——

There was some concern about the recent pace of decline in all measures of inflation expectations, in the United Kingdom and internationally, especially as there could be more downside news on inflation to be digested.

Inflation is going to zero soon: CPI inflation was expected by Bank staff to reach a trough of around zero in March, as lower oil prices fed through to petrol

In addition to lower utility bills, food prices, oil, and GBP strength, Bank staff’s central estimate was that around ½ percentage point of the deviation of inflation from the target reflected the weakness of domestic cost growth, a key element of which was wages.

It’s all about the risk to wages Inflation had fallen globally and was expected to reach its trough in the United Kingdom in the early part of the year when a large proportion of pay claims were settled. It was therefore possible that the pace of nominal wage growth would be weaker than otherwise and that this would feed into lower subsequent price inflation. In addition, the continued decline in oil prices was likely to contribute to a reduction in capital investment in the UK oil industry. Alongside these developments, it appeared that downside risks to the euro area had increased. Together, these factors could result in inflation persisting below the target for longer than previously expected

BUT there are 3 positives from the lower oil price:

First, the Committee judged that the lower oil price would, if sustained, act as a stimulus to growth in the United Kingdom and its main trading partners via its effect on the costs of production and real incomes. One early manifestation of this was that nominal incomes were likely to have been growing at a significantly faster rate than consumer prices in the second half of 2014. Second, market interest rates had fallen sharply and were already passing through to lower fixed rate mortgages. Demand would be stimulated further were Bank Rate to follow the path implied by market yields, although inflation
expectations had also fallen so the effect on real interest rates was smaller. Third, the early signs of a pickup in private sector average weekly earnings growth tentatively suggested that slack was either lower or being absorbed more quickly than previously thought.

And the hawks switched their vote because they got scared:

For the two members who had voted in the previous month for an increase in Bank Rate, the decision this month was finely balanced. They believed that the sharp fall in inflation to below the 2% target was probably driven largely by temporary factors and was unlikely materially to affect the behaviour of households and businesses in such a way that it became self-perpetuating. They also noted the most recent evidence that wage growth was more buoyant than they had expected. Nevertheless they noted the risk that low inflation might persist for longer than the temporary factors implied and concluded that this risk would be increased by an increase in Bank Rate at the current juncture.