the bank is behaving like an unreliable boyfriend

The Governor was in front of the Treasury Select Committee this week. Pat McFadden raised a laugh about forward Guidance - “The bank is behaving like an unreliable boyfriend, one day hot, one day cold, - people on the other side of the message not really knowing where they stand”. But is that really fair?

It is true there have been a lot of conflicting signals about when rates will rise! Following Mark Carney’s Mansion House speech, the odds in favour of a rate rise before the end of the year increased but then lengthened slightly, on the strength of sterling and the low inflation figures for May.

The Governor is advising markets, “forward guidance is state contingent”. As the state of the economy changes, the timing of future rate increases will also change. No need to wait for the Quarterly Inflation Report to mark the move. The situation is fluid and dynamic. As the data changes, so will future rate rise probabilities. “Don’t watch my lips - watch the data!” the new guidance.

Revisions to GDP data …
And so it was, the UK data changed, slightly, this week with the revisions to growth in the first quarter. The ONS revised down growth in Q1 from 3.1% to 3%! This is hardly likely to impact on monetary policy in any way shape or form. The adjustments reflect minor statistical adjustments rather than major structural moves. Our forecast of growth for 3% in 2014 is unaffected by the change.

Investment grabbed the headlines, increasing by almost 10% in the quarter. The year on year comparison was against a particularly weak quarter last year. We expect investment growth of over 7% for the year as a whole, using research data derived from the Manchester Index™. [GM Chamber of Commerce research data - capacity and investment intentions].

In the USA, the revisions to GDP growth in the first quarter were much more significant. The headlines confirm growth fell by 2.9% quarter on quarter. Yet, the underlying growth year on year was up by 1.5%. The FOMC expect US growth of 2.2% this year rising to over 3% next.

So what of Medium Term Rates …
In the UK, the governor would have markets believe rates will rise slowly and thereafter are unlikely to rise above 2.5% in the medium term. In the USA, the Fed present no such illusion. Medium term rates, according to members of the FOMC, are expected to rise to 4% plus and some members expect this to occur by 2016.

For now, US Bond traders believe the FOMC is too optimistic about the economy. Interest rates will remain low well into this decade. But if it does happen “over there”, is the UK - US spread manageable? Hardly likely. The medium term path of UK base rates is set to return to the 4.0% plus norm in due course, narrowing the divide. As for the timing - well that is another "guidance" issue altogether!

So what happened to sterling ...
The pound closed up against the dollar closing above the highly significant $1.70 level. Sterling closed at $1.702 from $1.70, slipping against the Euro to 1.247 (1.252). The Euro moved up against the dollar at 1.365 from 1.358.

Oil Price Brent Crude closed down at $111.35 from $114.70 as Middle East concerns cleared slightly. The average price in June last year was $102.92.

Markets, closed down. The Dow closed down at 16,771 from 16,945 and the FTSE was also down at 6,757 from 6,825.

UK Ten year gilt yields were down at 2.63 from 2.77 and US Treasury yields closed unchanged at 2.63. Gold was steady at $1,316 from $1,314.

That’s all for this week. Join the mailing list for The Saturday Economist or forward to a friend.

John
© 2014 The Saturday Economist by John Ashcroft and Company. Experience worth sharing.

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