BoE governor Carney has warned that a rate hike “could happen sooner than markets currently expect”.
The market had been expecting a hike in April 2015, so it’s easy to explain the price action on GBP assets whereby:
1) short sterling contracts are now fully pricing in a hike by Dec 2014, and
2) GBP TWI has seen further gains and is at a 5-1/2 year high.
The minutes of the June MPC meeting next week will provide more colour as to the likely timing, with expectations likely to rest on the Inflation Report month of November.
Carney has turned from dove to hawk in one speech, but the rationale for such a shift matters as much as the shift itself. The fact that the governor is speaking for the MPC committee suggests that the maths of hawks vs doves matters less. This will become clearer with the release of the June MPC minutes next Wednesday (June 18), which are likely to show a consensus developing for an early rate hike. This is likely to be enough to placate hawks such as Weale or McCafferty to stick with the consensus view.
What the minutes are also likely to show is growing unease from the BoE that the use of macroprudential policy tools would allow the economy outside of the housing market to continue growing strongly. An earlier rate hike is justified on the grounds that “growth has been much stronger and unemployment has fallen much faster than either we or anyone else expected”. But in achieving internal balance the governor sticks to the script that “gradual and limited” interest rate hikes will be required.
The key shift in view is that monetary policy is no longer seen as a last line of defence, which was the message of the May Inflation Report. Instead, Carney now says that “macroprudential policy is not a substitute for monetary policy”. Yes, the FPC will still announce limits on mortgage lending on June 26, but the BoE now wants us to view this as complementing the wider need for policy tightening.
Given that we are still in a yield-chasing and risk-loving environment, the fallout on Gilts should be limited as GBP, and GBP assets, remain attractive. At a time when the ECB is in easing mode and the Fed still discussing the technicalities of liftoff, the prospect of tighter policy from the BoE should see further gains on GBP vs the EUR and USD and thus more upside on GBP TWI.