BoE Deputy Governor Gives Crazy Speech Warning Markets Have Underestimated Rate Rises
On 2 November 2017, the Bank of England raised rates for the first time in a decade and Sterling’s initial rise was promptly sold off by forex traders as we discussed.
The 7-2 vote by the Monetary Policy Committee was not the unanimous decision some had expected, while Cunliffe and Ramsden saw insufficient evidence that wage growth would pick up in line with the BoE’s projections from just over 2% to 3% in a year’s time. Ben Broadbent, MPC member, deputy governor and known to be a close confidant of Governor Carney, gave a speech today at the London School of Economics (LSE) in which he warned markets that Brexit issues didn’t necessarily mean that interest rates have to remain low.
Bloomberg reports that Broadbent stated that the Brexit impact on monetary policy depends on how it affects demand, supply and the exchange rate.
“There are feasible combinations of the three that might require looser policy, others that lead to tighter policy.”
Which sounds alot like he doesn’t know, although he stuck to the central bankers trusty tool, reassuring LSE students the Phillips Curve “still seems to have a slope”.
According to the FT.
The deputy governor of the Bank of England has warned that financial markets have underestimated the chance of further interest rate rises. In a speech at the London School of Economics on Wednesday, Ben Broadbent said markets had placed too much emphasis on the idea that interest rates needed to be kept low in the face of Brexit uncertainty. The deputy governor said it was “uncertain” and “complex” to anticipate how Brexit would affect inflation. But he rejected the assertion that Brexit “necessarily implies low interest rates”.
“Even as inflation rose, and the rate of unemployment fell further, interest-rate markets continued to under-weight the possibility that (the) bank rate might actually go up this year,” he said.
The BoE’s Monetary Policy Committee announced its first interest rate rise in more than a decade earlier this month. But the central bank has struggled to convince financial markets that it is likely to raise rates further.
BoE officials were taken aback when sterling sold off on the day it announced the rate rise, and two-year gilt yields remain below the BoE base rate, suggesting markets are sceptical that the MPC will raise rates further while there is still considerable uncertainty around the UK’s economic future outside of the EU.
Broadbent acknowledged that there is a risk that Brexit uncertainty could adversely impact UK demand. However, he sees the potential for other factors, a reduction in trade, for example, which could crimp UK capacity and necessitate a rise in rates. While Broadbent’s thinking is flawed, and his barley field example plainly ridiculous, the FT continues.
Brexit-related uncertainty could weigh on demand and motivate the MPC to keep interest rates low to support the economy, but other factors could push the central bank to raise rates.
For example, if Brexit reduced the UK’s openness to trade, the country’s output capacity could suffer, which would require the BoE to raise rates to temper inflation.
“Economists often presume that changes in an economy’s underlying productivity occur only slowly,” Mr Broadbent said. However, he added: “A sharp reduction in the degree of openness (to trade) could have a more immediate impact. “A field currently producing barley, sold into the European market, can’t easily or as fruitfully be replanted with olive trees”. He said the challenge for monetary policymakers was that “reductions in supply can add inflationary pressure even as they lower aggregate (gross domestic product)”.
So, let’s consider Broadbent’s example…
The UK suffers a drop in aggregate demand due to a contraction in trade, the BoE raises rates in an over-leveraged economy to stem the inflation and…undoubtedly makes the contraction in GDP much worse. That makes no sense and is the kind of one dimensional thinking that we’ve had to put up with from central bankers. What’s worse is that Broadbent has specific responsibility for monetary policy and a c.v. as long as your arm – Cambridge, Harvard PhD, Fulbright Scholar, Columbia University, Goldman Sachs and UK Treasury.
It’s no wonder we are in such a mess with people like this pulling the levers of policy in the central banks. Crazy ideas aside, Broadbent and his BoE colleagues might be unhappy with market projections for the future path of interest rates, but they can hardly blame investors for being sceptical.
Which way are rates going, Ben?