Edging Closer?

17th June 2014

Over the past week the market has been fixated on the shift in tone from the Governor of the Bank of England, Mark Carney, during last week’s Lord Mayor’s Banquet for Bankers and Merchants of the City of London at the Mansion House, when he signalled a potential shift in the BoE’s stance on interest rates.

His normal dovish tone was replaced some surprising hawkish comments, stating
“There’s already great speculation about the exact timing of the first rate hike and this decision is becoming more balanced. It could happen sooner than markets currently expect”.

Although it is not clear if this was his position or he was simply reflecting the views of the MPC, the FTSE weakened and sterling strengthened (the pound rose to $1.6986 – taking its rise to over 8% in the past 12 months and making it even harder for UK exporters). Either way it sits uncomfortably with inflation data, which suggests that there is no immediate need for higher interest rates.

The Office for National Statistics said today that consumer prices (CPI) rose 1.5% year-on-year. Not only is that the least since October 2009, it was significantly below market expectations of 1.7%. Inflation has been at, or below, the central bank’s 2% target for six months, the longest stretch since 2009 and Goldman Sachs believes that there is a 30%-40% risk of UK CPI slowing to below 1% by year-end! We also need to watch Europe where Mario Draghi, the ECB’s President is trying to prevent deflation (Euro area inflation fell from 0.7% to 0.5% in May).

Mark Carney’s comments may have been directed towards cooling down the UK property market (by changing expectations), but the BoE has other powers that it could use to take the heat out of the housing market (such affordability testing). It is very important that the BoE does not derail the overall economic recovery, which is still in its infancy, by raising interest rates too soon.