The great monetary policy dilemma | interactive investor

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The great monetary policy dilemma By Emil Ahmad | Thu, 29th June 2017 - 11:15 Global central bank policy has been a focal point of discussion over the last few weeks, as the market first digested the Federal Reserve's second interest rate rise of 2017, then conflicting comments from Bank of England (BoE) governor Mark Carney. Despite a softer inflation number, this tightening US credit cycle continues to gather pace. The target range for the Fed Funds rate now stands at 1.25%, with an additional quarter point rise expected by the end of the year. An increasingly hawkish stance from Fed chair Janet Yellen suggests this cycle will gain further momentum in 2018. With US policymakers suggesting 3% could be the new benchmark, the City is standing up and taking notice. It certainly appears that the Bank of England and Carney are paying attention. As Brexit negotiations begin, a clear mandate for UK monetary policy is essential for an economy compromised by ongoing uncertainty. UK consumers are awaiting further clarity on what it means for them.

MPC majority narrows The Monetary Policy Committee (MPC) recently voted to keep UK interest rates on hold at 0.25%. While the outcome was expected, the first rumblings of discontent have emerged. The vote was only 5 to 3 in favour of keeping the status quo.

This resistance may be temporary, with one of the 'dissenters' departing the fray imminently. New member Silvana Tenreyo will be at July's meeting, with market sentiment suggesting she may be more dovish. If her appointment results in a 6 to 2 outcome, this additional clarity may help Carney get his house in order.

Carney responds, but is he wrong again? In his Mansion House speech, Carney said now is not the time to raise interest rates. Indeed, Carney's view is at odds with BoE chief economist Andy Haldane. Nomura economist George Buckley says Haldane's call for a rate rise this year, combined with that 5-3 vote among rate setters, made an early rate move likely. The decision is clearly not a straightforward one for Carney who, a week after his last speech, sent the pound soaring after admitting MPC members could vote through an increase if business investment rises. The base rate was cut to 0.25% last year, representing the first change since 2009, as the MPC had anticipated a hit to the economy after the EU referendum. However, economic data has been stronger than expected since then and investors argue that the Bank was wrong to cut the rate given growing evidence that money supply is starting to accelerate, an inflationary signal. There's talk the MPC may be willing to reverse this cut, but this does not necessarily constitute a change in monetary policy. Carney's reluctance to reassess unprecedented stimulus measures he introduced last August could be telling for UK households. The idea behind sticking with a historically low base rate is that Carney wants to see how weaker household spending is countered by healthier trade or a recovery in investment. This balancing act is likely to gain in complexity as political manoeuvrings increase over the course of Brexit negotiations. Higher interest rates can help combat inflationary pressures on disposable income and household budgets. Conversely, increased borrowing costs may further marginalise lower income consumers by reducing access to credit and burdening borrowers with higher debt repayments.

Costs keep rising Inflation is an ongoing concern for the UK consumer. The Office for National Statistics' (ONS) Consumer Price Index (CPI) rose to 2.9% in May, an increase of 0.2% over April. That's the fourth consecutive month inflation has exceeded the Bank of England's 2% target. The CPI gauges movement in cost of a representative basket of consumer goods and services typically bought by UK households. More expensive goods and services erode the purchasing power of every pound earned. For families trying to maintain existing standards of living, the bottom line paints a sobering picture. In mentioning subdued domestic pressures, Carney arguably sees continuing sterling weakness as the main driver behind rising costs as he looks beyond an increasing CPI. Recent forecasts from the central bank had anticipated inflation would hit 3% by the end of the 2017, slowly dropping back to target in 2018 and 2019. As May's 0.2% rise was unexpected, additional inflationary 'shocks' may further divide the MPC in months to come.

CPI and interest rates movement since financial crisis



Brexit will tell There's little doubt that the BoE is very mindful that monetary policy must be supportive of economic growth as the Brexit process develops. Given such uncertainty about the final deal with the EU and its potential impact on the economy and sterling, the BoE will think long and hard before increasing borrowing costs for the first time in a decade. This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.

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The great monetary policy dilemma | interactive investor

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