Can the Bank of England defy recent global central bank developments?
The age of monetary policy normalisation never really got going. Sure, the US Federal reserve delivered nine rate hikes since 2016, but elsewhere central banks have continued to battle low inflation, low productivity, and sluggish wage growth.
The European Central Bank, for instance, only got around to ending its massive quantitative easing programme at the end of 2018. The benchmark rate is still zero and the deposit rate still in negative territory.
Rates are negative in Japan as well, where QE is still running. Meanwhile, the Reserve Bank of Australia and Reserve Bank of New Zealand were mostly holding rates steady.
Hawkish expectations take a dive
Rewind twelve months and things were very different. The Federal Reserve was well into its normalisation cycle, having delivered multiple rate hikes and discussed unwinding its enormous balance sheet - a hangover from the QE implemented after the financial crisis.
This was leading other central banks to act more hawkishly; the European Central Bank shelved quantitative easing and markets started discussing when the first hike would be.
It was expected that Australia and New Zealand's frozen rates would thaw and move higher in the not-too-distant-future.
Meanwhile, in the UK, it seemed that it was only Brexit that was preventing the Bank of England from upping borrowing costs.
It's fair to say things have changed somewhat. Although where the Bank of England should stand remains up for debate.
Fed confirms market expectations, signals rate cut
The Federal Open Market Committee meeting concluding on June 19th saw policymakers admit what the market had been expecting for some time: cuts were coming. There seems to be a big gap between where the FOMC is likely to stand and how dovish markets expect it to be, however.
According to futures data from CME group markets have priced in a 100% chance of at least one rate cut by December, with three being the strongest case.
Meanwhile the European Central Bank recently admitted it's not as confident in a H2 pickup as it was previously. A few months ago, the Governing Council decided to schedule another round of Targeted Long-Term Refinancing Operations (TLTROs) for September, and the prospect of the first-rate hike since 2011 has been pushed back to 2020 H1 at the earliest.
Meanwhile in the antipodes, the Reserve Bank of Australia recently delivered its first policy tweak since August 2016, cutting the official cash rate to a new historic low of 1.25%.
This follows a similar move from the Reserve Bank of New Zealand, which cut rates 0.25% to 1.5% a month earlier.
Brexit complicates UK policy outlook
The Bank of England remains something of an anomaly. The UK labour market has been strong for some time, with employment trending around it highest since the mid-70s. Inflation is near target and political uncertainty has had little negative impact upon consumer spending.
While the pound is still incredibly vulnerable to Brexit news flow, policymakers are unsure how much longer they can wait before addressing the issue of price growth.
The problem facing the monetary policy committee is that current conditions are temporary, whichever way you look at it. Brexit might be as terrible as the doom mongers predicted, choking economic growth and pushing up unemployment, which means policy needs to be loosened.
Or the UK will enter a golden new age of economic prosperity, requiring higher borrowing costs and the winding down of the balance sheet to prevent overheating.
Even if the outcome is somewhere in the middle, sterling's weakness compared to pre-referendum levels will continue to fuel inflationary pressures, and once we get any kind of Brexit underway businesses and their international consumers will no longer be in wait and see mode.
So, does Threadneedle Street set policy for the economy it has, or for the economy it is going to have - whatever that may look like? Changes can be undone - as we saw when the post-referendum rate cut was reversed a little over a year later.
But this is about the trajectory, not minor adjustments. Is this really the right time to be cranking the gears on a tightening cycle when the rest of the world (led by the Fed) have turned dovish again?
This article was submitted by Markets.com.
