BoE: Could Forward Guidance Be Due for Another Change? - Fidelity
Paras Anand, Head of European Equities at Fidelity International, suggests that when Mark Carney unveiled his forward guidance policy in 2013, he hoped it would create a stable platform of interest rate expectations to support long-term investment in the UK.
“In reality, the Bank’s guidance has repeatedly proven sensitive to short-term developments in the global economy, failing to provide the very thing for which it was designed.
The Bank’s current guidance suggests that we should not expect a rate rise until 2017, and Mr Carney has even hinted that the next move in rates may be down rather than up. Very low yields in bond markets reflect this strong steer.
However, Paras Anand, believes investors may be missing changes in the economic climate which could upend these expectations. He highlights five factors that could surprise forecasters and push inflation (and with it, interest rate) expectations higher:
Higher energy prices
Oil prices have now risen to around $50 from $30 in January, higher than most forecasts at the beginning of the year.
Stronger labour markets
Carney’s initial guidance to markets was that rates would not rise before unemployment fell below 7%. As unemployment dropped he had to ditch this guidance and later revised it further to say the Bank would react only after wage growth picked up. Unemployment has dropped to 5.1% (one of the lowest rates among major economies) and we have recently begun seeing rises in nominal wages. Pressure on inflation ought to follow.
Sterling is at multi-year lows against the Dollar and Euro. A drop in the purchasing power of a currency should import inflation into the country but we are yet to see this comprehensively factored into City forecasts.
The major falls in oil and food prices (which were themselves not accurately forecasted) will soon be more than 12 months old and will drop out of the year-on-year change in prices which are, in turn, reflected in inflation.
Money supply & velocity
Money supply in the UK and other developed markets has grown considerably as central banks have conducted massive amounts of QE. However, an increase in the movement (or velocity) of this enlarged supply of money from current low levels would have a meaningful impact on inflation expectations. For the moment it remains hard to determine when those pent up animal spirits might be released.
Anand continues: “When we form our expectations for the future, most of us tend to be heavily influenced by our recent experiences. This bias is often at work in financial markets, where the longer a certain trend persists, the more comfortable people seem to become that it will continue into the future. Although we have all become used to a low inflationary and interest rate environment, this is a highly unusual state of affairs: rates are lower now than at any time in the Bank of England’s 400 year history. Investors should be aware that any change in expectations will have significant implications for performance in financial markets.”