Overall, Mark Carney's second Inflation Report as Governor of the Bank of England was fairly upbeat. The main points to note from the Bank's forecasts include:
The near term inflation outlook has been revised significantly lower.
The Bank thinks that the economic recovery will be sustained.
The Bank expects the unemployment rate to fall to 7% in Q3 2015, significantly earlier than the Q2 2016 forecast included in the August Inflation Report.
In contrast to his predecessor, Carney has been in the unusual position as BOE governor of having to revise lower the Bank's Inflation forecasts, Mervyn King famously had to revise them higher quarter after quarter as prices in the UK remained sticky. Carney had to deal with plenty of questions about 1, why the BOE's forecasts always seem to be behind the curve and 2, what is the point of forward guidance if the Bank can't even get the economic thresholds right. Carney responded by saying that forecasts are not an exact science, a fairly limp answer…
The BOE has moved in line with market expectations for rates (the GBP overnight index linked swaps curve was pricing in for a rate hike in Q2 2015 in the lead up to this meeting), however it has tried to limit the extent of good news by concentrating on other indicators apart from the unemployment rate that remain fairly weak. For example, although jobs are being created, people are not working as many hours as they would like, which is one reason why the BOE's Charles Bean said "we're confident that there is substantial slack in the UK". Weak wage growth and the fact that the UK economy and the number of people employed are both lower today compared to before the 2008-09 downturn are keeping the BOE cautious. Carney made this clear when he said it would be foolish to raise rates today. Thus, while the BOE is acknowledging the better tone to economic data tightening policy is not on its radar yet and forward guidance is still designed to keep a lid on UK yields.
The market reaction to this report has, so far, been fairly muted. Although GBPUSD surged to 1.60 as Carney started talking, it has moderated back to 1.5950. Likewise, EURGBP made a low of 0.8390 and is now creeping back above 0.8400. 10-year UK Gilt yields rose to a high of 2.85%, however they too are falling back during the Q&A session.
The reason for the muted response in our view is that the market expected this shift in the BOE's forecasts. It has already priced in a rate hike for some time in the second half of 2015, so upside pressure on sterling and Gilt yields as a result of this Inflation Report was always going to be limited as we said here.
Overall, the BOE did move towards the market's view, as we expected. Going forward, the BOE can rest easy - inflation is falling while growth is rising, which can support policy remaining on hold for some time. We believe we will have to see the entire economy get back above 2008-09 levels to spur the BOE to action, and that could still take some time.
The near term inflation outlook has been revised significantly lower.
The Bank thinks that the economic recovery will be sustained.
The Bank expects the unemployment rate to fall to 7% in Q3 2015, significantly earlier than the Q2 2016 forecast included in the August Inflation Report.
In contrast to his predecessor, Carney has been in the unusual position as BOE governor of having to revise lower the Bank's Inflation forecasts, Mervyn King famously had to revise them higher quarter after quarter as prices in the UK remained sticky. Carney had to deal with plenty of questions about 1, why the BOE's forecasts always seem to be behind the curve and 2, what is the point of forward guidance if the Bank can't even get the economic thresholds right. Carney responded by saying that forecasts are not an exact science, a fairly limp answer…
The BOE has moved in line with market expectations for rates (the GBP overnight index linked swaps curve was pricing in for a rate hike in Q2 2015 in the lead up to this meeting), however it has tried to limit the extent of good news by concentrating on other indicators apart from the unemployment rate that remain fairly weak. For example, although jobs are being created, people are not working as many hours as they would like, which is one reason why the BOE's Charles Bean said "we're confident that there is substantial slack in the UK". Weak wage growth and the fact that the UK economy and the number of people employed are both lower today compared to before the 2008-09 downturn are keeping the BOE cautious. Carney made this clear when he said it would be foolish to raise rates today. Thus, while the BOE is acknowledging the better tone to economic data tightening policy is not on its radar yet and forward guidance is still designed to keep a lid on UK yields.
The market reaction to this report has, so far, been fairly muted. Although GBPUSD surged to 1.60 as Carney started talking, it has moderated back to 1.5950. Likewise, EURGBP made a low of 0.8390 and is now creeping back above 0.8400. 10-year UK Gilt yields rose to a high of 2.85%, however they too are falling back during the Q&A session.
The reason for the muted response in our view is that the market expected this shift in the BOE's forecasts. It has already priced in a rate hike for some time in the second half of 2015, so upside pressure on sterling and Gilt yields as a result of this Inflation Report was always going to be limited as we said here.
Overall, the BOE did move towards the market's view, as we expected. Going forward, the BOE can rest easy - inflation is falling while growth is rising, which can support policy remaining on hold for some time. We believe we will have to see the entire economy get back above 2008-09 levels to spur the BOE to action, and that could still take some time.
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