Focus on central banks shifts to BoE and ECB
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Today we have Mark Carney’s second meeting as the head of the Bank of England (BoE), but whilst he will no doubt aim to have an impact, dovish inclinations look set to collide with an improving economy. UK GDP expanded by 0.6% qoq in Q2 while the PMI surveys suggest that at long last the economic recovery is gaining traction. Given this, on balance we expect the Bank of England to keep policy unchanged on Thursday. However realistically this should be seen as a close call, with the chance of a dovish surprise.
We anticipate that forward guidance will be discussed and any details will be released at the Inflation Report on 7th August and certainly we expect some form of forward guidance to be implemented. Both the statement and the minutes of the last MPC meeting referred to the fact that the policy discussion could be affected by the analysis and conclusions of the debate on forward guidance, and in May, Mr Carney spoke about the importance of a central bank “putting its money where its mouth was” with reference to forward guidance, implying that the message should be backed up by some palpable policy easing. The July minutes then made reference to the fact that a broader suite of policy tools would be examined and made available to the MPC at the August meeting. Those are likely to be supported by the two MPC members who previously have voted for more easing, but may also be supported by Mr Carney and other members who had become less convinced of the benefits of continuing to buy Gilts under Quantitative Easing.
The possible policy tools they could vote for could be a cut in the rate the bank pays on reserve balances, whilst keeping the Bank Rate at 0.5%; a further easing of the terms of the FLS; or a broader range of asset purchases including assets other than Gilts. Arguably a cut in the rate paid on reserves is the most likely possible initiative, and despite the recent strength in cyclical data in the UK and Europe, it could prove a close call given the likely introduction of forward guidance. As such, markets should prepare for the possibility of a dovish surprise.
Mr Carney may also again highlight the fact that the increase in UK long yields, in sympathy with the moves in the US, has effectively tightened UK monetary conditions. As well as trying to push yields back down, he will implicitly want also to weaken the pound but any dip on the day, particularly if he surprises with an interest rate cut, could well prove relatively temporary.
Turning to the European Central Bank (ECB), it’s just over a year since Mr Draghi’s now famous commitment to “do whatever it takes to preserve the euro, and believe me it will be enough.” (26.7.12). Interestingly the ECB has yet to purchase a single bond, with the mere promise of acting like a real central bank allowing Euroland to face many risk events, avoiding another fully fledged panic, and we do not expect any further policy innovations from the ECB today. But Mr Draghi is likely to reiterate the fact that policy rates are likely to stay low or lower for an extended period. Against this backdrop, while the euro could dip as Mr Draghi once again reiterates his intention to keep policy accommodative for a long time, any dip in the euro may prove to be a buying opportunity. The context of course is that despite acute pessimism early in the year, rather than beginning to price break- up risk again, markets are responding to recent evidence that suggests that a weak European recovery is at hand.
James Bevan is chief investment officer of CCLA, specialist fund manager for charities and the public sector. CCLA launched The Public Sector Deposit Fund in 2011 to meet the needs of local authorities and other public sector organisations. You can follow James on twitter @jamesbevan_ccla
