BoE Watch

2 min read
Divyang Shah

The latest speech from BoE MPC McCafferty is confirmation that even the hawks are comfortable with current market pricing of a BoE rate hike in mid-2016. Instead of pointing to reasons for hiking interest rates we see McCafferty expand on why the BoE did not loosen policy in the face of low and falling inflation.

The standard answer from McCafferty is that the factors behind the fall in inflation are temporary and will reverse at the end of the year. His estimate of spare capacity is 0.5% so continued growth and a turnaround in the temporary factors weighing on inflation suggests that he will likely vote for a rate hike in Q1 2016.

Mccafferty mentions lower oil, lower food, stronger GBP and weaker wage growth as factors weighing on inflation. What is interesting is that while it is understandable that the impact of oil, food and the exchange rate on inflation will weaken, it is difficult to see this line of thinking holding for wages. The speech highlights how wage growth has been halved since 2008 from the 4% average during the period 2001-07.

The weakness in wage growth and weaker productivity growth are issues that have impacted the G7 and have been difficult to model using standard economic models. We have seen the Riksbank and RBNZ provide us with a lesson on the dangers of premature tightening with attempts by both to be preemptive seeing them forced to reverse course.

Inflation in both Sweden and New Zealand has not proved to be the problem that each central bank thought it would be when they embarked on monetary policy tightening. We are tasked with forecasting what the BoE is likely to do, not what it should do and on this basis we see the first hike from the BoE in Q3 2016. The risk is that it will happen later rather than sooner and will not happen until the Fed has begun to normalise its own monetary policy.

Divyang Shah