Two thoughts to end the week : Sooner or later, the BoE's going to have to do more than talk a good game ..... and how bad would the N. Korea thing have to get to ruffle this market ?

Friday 15th September 2017

  

Two thoughts to end the week : Sooner or later, the BoE's going to have to do more than talk a good game ..... and how bad would the N. Korea thing have to get to ruffle this market ?

ref : General, and "Economists divided as BoE ramps up rhetoric....." , The Financial Times

N. Korea first ..... and news overnight of another missile fired over Japan into a spot in the Pacific 3,700km away. The distance is significant and quite deliberate, being almost exactly the same as that between N. Korean launch sites and the US territory of Guam. The threat could not have been more obvious. 

Six minutes after the launch, S. Korea let fly with some missiles of its own at an imaginary target 250km out to sea ..... which, as it happens, is also the distance between its launch sites and Pyongyang, Get the message, everybody ? 

We must be getting old and jumpy ..... does anyone else find these developments at all disconcerting ? Not many, if the "Ho hum" reaction of markets is anything to go by. Admittedly, that traditional safe-haven the Swiss Franc has been in demand, but the other boltholes US Treasuries and Gold are trading lower. Stock indices indices in Seoul and Tokyo actually finished up on the day would you believe, and as for the Jap Yen ..... there was a knee-jerk reaction to buy the Japanese unit but the move reversed itself almost immediately  ..... and more. Having traded down through JY110, USD / JPY is now at JY111.25 as we write.

Of course, it's just possible that traders are reassessing the logic behind buying Yen when, literally and metaphorically, Japan is in N. Korea's firing line ..... though we wouldn't bet on it. More likely, it seems that markets have just become inured to the sabre-rattling, and will remain phlegmatic unless and until something truly desperate happens. As one emerging markets guru, Mark Mobius of Templeton Emerging Markets Group, put it :

"There's nothing you can do about it  --  if something breaks out, we're all finished anyway".

That's admirable in its own way, and at the same time more than a little alarming.

  

So, since it seems de rigeur to put N. Korea to one side, there's little doubt about the main story of the last 24hrs  --  the Bank of England, its rate decision and the surge in the value of Sterling.

Actually, that's a little misleading ..... it wasn't so much the decision that has kicked things off, as the talk (or rather the minutes of the meeting) that followed it. A "No Change" outcome was widely expected and delivered, and in fact the continuing 7 to 2 majority on the committee  in favour of that course surprised some who thought that rising inflation numbers might push at least one more member into a more hawkish stance. It was not to be ..... but those minutes were the real story. Of course the market was expecting some confirmation that the BoE was keeping a concerned eye on inflation data, but the minutes delivered warnings about the chances of future rate rises that were much more hawkish than predicted.

A sizeable proportion of economists were, and still are, of the opinion that the slowdown in growth brought on by Brexit should supersede concerns about inflation and were thus sceptical about the possibility of a rate hike in the foreseeable future. Those suggesting that such a move wouldn't happen until 2019 may have been at the extreme end of things, but prices in the overnight index swap market  --  which shadows official interest rates and is widely used as a gauge of rate move probabilities  --  did not predict a rise before late-2018 as recently as a week ago. By the end of trading yesterday, they were suggesting that the chance a hike as early as this November were nearly 50%, and a move was fully priced in by February next year,

In case we hadn't quite got the picture, Monetary Policy Committee member Gertjan Vlieghe has been reiterating the warnings about inflation-related rate rise(s) this morning  --  and Mr Vlieghe is generally considered to be something of a dove. Probabilities are higher again, and as a result Sterling has jumped from $1.32 to $1.36 in 24hrs, and from €1.11 to €1.1350.  Yields on the 10yr Gilt, at 0.97% just a week ago, topped 1.33% at one point this morning  --  significant moves indeed.

The BoE might have some mixed feelings about the rise in yields, but in other respects might be very happy with developments. Effectively, they've talked Sterling higher  --  which if sustained should alleviate inflation pressure  --  without actually having to lift short-term rates, which might damage growth. There's a problem , though .....

The Bank of England is getting an unwelcome reputation for signalling rate increases in the pipeline and then not delivering ..... for "crying wolf". Soon after Mark Carney became Governor in 2013, the BoE stated that it would consider raising rates when unemployment fell below 7%. The jobless rate is now 4.3% and interest rates are actually lower now than they were then. In 2014, the Governor warned that rates were likely to rise sooner than the markets thought. Well, they thought then that rates would be at 2.25% by now, when in fact they are at 0.25% . He was at it again in 2015, saying that key interest rate decisions would be faced at the turn of the year  --  another prediction that failed to materialise.

To be fair, global developments can overtake the best-laid plans and certain events  --  Brexit, for example  --  can really make anyone look a bit stupid. But you can understand why plenty of people are becoming sceptical of the Bank of England's announcements .... and they're sceptical too about the wisdom of raising rates when the economy is slowing down, notwithstanding higher inflation readings that in any case might be short-lived. Which means things could get a bit awkward for the Bank if they should be forced to reconsider once again after all they've come out with over the last 24hrs.

All central banks are prone to "jaw-boning" markets to greater or lesser degrees, but there are only so many times you can get away with it. There are lines not to be crossed, and in repeatedly suggesting a future course of monetary policy and then not following through with it, the BoE is running the risk of being accused of one of two things. EITHER they keep reading things incorrectly, which would make them incompetent, OR they have been misleading the market about their intentions, which would make them untrustworthy.

For our own part, we don't believe the Bank has been guilty of anything more than saying too much, too soon (which some might characterize as incompetent), but we worry that they may be painting themselves into a corner. If they don't now deliver on a rate hike sometime soon, even if the economic fundamentals for it are unconvincing, the damage to the BoE's credibility may be more than this regime can bear.

Have a nice weekend, Mr Carney.