3 Reasons to Hike. All of them depressing.
(Typed on an iPhone because this seemed too long for Twitter, please forgive any typos).
What on earth is going on at Threadneedle Street?
After easing last year the Bank seems to have performed a sudden about turn and be set to tighten policy, possibly as soon as November.
This appears to be a bit odd. The UK economic outlook is far from rosey. Growth is soggy and Brexit related uncertainty high. Unemployment is extremely low by historical standards but then so is nominal earnings growth. Yes, inflation looks set to breach target but that is still mainly an FX story.
Assuming we discount the “peer pressure” argument (“well, the Fed’s doing it, the BOC’s doing it, even the ECB might do it soon… why aren’t we?”) I can see three explanations for what is going on. None of them reassuring.
1. A Jedi Mind Trick
The most simple explanation is that nothing is happening. This is just a bit of verbal intervention to talk up Sterling and dampen some of those FX related inflationary pressures.
If so, it seems an ill advised one. The Bank – and the Governor – have doubled (or really tripled) down on this one: a hawkish hold in August, an extremely hawkish hold this week and then the Governor taking to the airwaves to push the message again.
I’m not a fan of arguments based on credibility (“I must do the wrong thing to protect my credibility”) but the Governor has now staked too much on this to easily reverse course with hitting his.
If this is a central bank Jedi mind trick, they’ve pushed the comms strategy too far and limited their room for manoeuvre too much.
Explanation one is depressing purely because if this was an attempt to just jolt the pound, it’s a badly done one.
2. Imbalances/Financial Stability
This one is another possible. Maybe the Bank’s real concern isn’t the inflation target but financial stability. Perhaps a period of rates being too low for too long will lead to a build up in imbalances and put financial stability at risk. As Chris Gile’s puts it in the FT today, think the 2000s not the 1970s. Perhaps.
It’s a perfectly valid argument. And certainly one that is getting an airing at the Fed and the ECB.
But it is still depressing. It represents the failure of the hot new thing in central banking: macro prudential policy.
The whole point of having a separate Monetary Policy Committee and a Financial Policy Committee was to have two sets of tools to deal with different problems.
A financial stability driven hike would be an admission that that approach isn’t sufficient.
3. Trend growth
I think this is the actual driver of Bank policy. A reassessment of trend growth.
It seems to me that the members of the MPC have become increasingly pessimistic on the level of output growth the UK can sustain given a decade of weak productivity and slower workforce growth (and Brexit – by increasing uncertainty (which impacts investment) and possibly slowing immigration plays a role here).
If the Bank now thinks trend growth is more in the region of 1.5% than 2.5% then the shift makes sense.
How else to square the August forecasts & messages of “growth is going to be quite tepid, incomes squeezed and, oh well, we’ll have to tighten anyway”.
As I put it last month… the long run may have arrived, the point at which weak productivity growth becomes a live issue for monetary policy.
This explanation may make sense but is, if anything, the most depressing of the candidates. It’s the equivalent of saying that the current UK outlook is basically as good as it is going to get for a while.
And how else can one interpret an Andy Haldane speech which basically said “the UK labour market has changed and now doesn’t generate much wage growth. So we’ll have to hike soon”?
As an aside – if the OBR joins them in this productivity pessimism camp, then expect some grim fiscal numbers in the best forecast round at the Budget.
The bigger question
Sitting behind all of this questions is a bigger one. Is the MPC talking about just reversing last year’s additional stimulus or is this the start of an actual hiking cycle?
If the driver of the change in the Bank’s view is a serious downgrade in its estimate of trend growth then this may actually be a hiking cycle – not just the reversal of last year’s cut but a process that takes rates higher. Probably not too much higher, we are not talking about base rate anywhere near the old normal of 5% but still – unwelcome news for many households.