Is Bank of England Confused ?

“On Prima Facie the job of central banker is a lot similar to a doctor, the only problem is central banker has to prescribe the medicine well before any sign of illness” – Anonyms

Providing a clear roadmap of likely monetary policy actions is a key challenge for the global central banks. Major central banks, including US FED, have been proactive to provide forward guidance and share the underlying basis for their policy actions. The prime objective of such moves is to reduce the surprise factor in central banking, which helps to curb wild financial market movements. Though, the timing of US interest rate hike is debatable, but there is no doubt that financial markets were fully prepared for the move. The volatility in financial markets remained broadly unchanged when US FED hiked the interest rate first time in over a decade.

Though, it is difficult to predict the timing and quantum of monetary policy actions, but the direction of the move can be predicted with reasonable certainty. For example the next policy action by Reserve Bank of India, People Bank of China, Bank of Japan and European Central Bank will be towards monetary easing. On the other hand, the policy action by US FED will be towards monetary tightening. Bank of England can-not be classified with same certainty as BoE officials have been all over the place over likely policy action. BoE Governor, Mark Carny has been vocal about interest rate hike for last 15 months. Interestingly, Carney does not face any trouble while shifting his stance frequently, much to displeasure of the traders Carney’s continuous shifting of stance has little correlation with underlying economic numbers. UK’s consumer inflation, which had been roaming in negative territory, has remained below 0.3%. The sustained low inflation can be attributed to slump in crude oil prices and weak wage growth, which if achieved responsible for secondary inflation in economy. The industrial activity in UK is also remained more or less in negative territory indicating that economy has long way to go before any possible interest rate hike.

Clueless Cable:

A close look at weekly movement of GBP/USD pair underlines the failure of Bank of England’s forward guidance and communication. After UK’s election, GBP/USD pair rallied more than 1600 pips on the expectation of interest rate hike, which expectation was fuelled by hawkish comments from BoE officials. BoE even claimed that it will second major central bank to hike the interest rates after US FED. BoE’s CPI projections have been all over the place, to put things into perspective actual inflation in December 2015 at 0.2%, is 90% less than its forecast of 1.9%. Though, ultra-low crude oil prices are key factor but wage growth has also remained subdued. It is noteworthy that BoE’s chief economist Mr. Andy Haldane has argued about possibility of interest rate cut to combat inflation.

Over the last one month, GBP/USD pair has corrected more than 1000 pips owing fading expectation of interest rate hike. The sharp decline in the pair should be attributed to free-fall in crude oil prices as ultra-low crude oil prices will ensure that underlying inflation will remain subdued and far from BoE’s December 2016 target of 1.6%.

Just like any other field, macro-economic theories are also evolving. In current scenario Philip Curve, which shows inverse relationship b/w unemployment rate and inflation, is under scanner. A falling unemployment rate is no longer guarantee for spike in inflation, which has make the job of central banker trickier.

Source: Bank of England