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Business News/ News / World/  Carney breaking from Draghi-Yellen inaction in market bets
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Carney breaking from Draghi-Yellen inaction in market bets

The BOE will lift rates in the second quarter of 2015 and the Fed will increase in 2016, Morgan Stanley predicts

MarkCarney, governor of Bank of England. Photo: ReutersPremium
MarkCarney, governor of Bank of England. Photo: Reuters

London: Investors are betting Bank of England Governor Mark Carney will lead the charge out of record-low interest rates as central banks pivot from fighting stagnation to managing expansions.

Economists at Citigroup Inc. and Nomura International Plc say the strongest growth since 2007 will prompt the UK to lift its benchmark from 0.5% as soon as this year. Money- market futures show an increase in early 2015. That’s at least three months before the contracts indicate Federal Reserve chairman Janet Yellen will raise the target for the federal funds rate. European Central Bank president Mario Draghi and Bank of Japan governor Haruhiko Kuroda are forecast to maintain or even ease monetary policy.

Carney and BOE officials will be looking at the domestic recovery, and if that is strong enough, then they will feel comfortable increasing rates before the Fed, said Jonathan Ashworth, an economist at Morgan Stanley in London and former UK treasury official. Tightening by the major developed central banks will be gradual, and they will be aware of what everyone else is doing.

The BOE will lift rates in the second quarter of 2015 and the Fed will increase in 2016, Morgan Stanley predicts.

This wouldn’t be the first time Carney, 48, has broken from the pack. As governor of the Bank of Canada, he abandoned a conditional commitment to keep rates unchanged until July 2010, citing faster-than-expected growth and inflation. He delivered a rate increase in June of that year, putting him ahead of other Group of Seven central bankers.

First-mover risk

The risk of being first this time is that the divergence pushes up the U.K.’s currency and bond yields, threatening to choke off its economic upswing.

Acting before the Fed—now led by Yellen, who was sworn in today as chairman—would require a very big stomach for having sterling rise, former BOE policy maker Adam Posen said in a 8 January interview.

While all economists surveyed by Bloomberg News predict BOE policy makers will leave their official bank rate unchanged when they meet 6 February, Carney may seek to quell expectations for increases when he releases new economic predictions 12 February.

Investors pushed up Britain’s borrowing costs as consumer spending powered the economy back from recession. The pound has already climbed to the highest level in more than 2 1/2 years against the dollar, and the extra yield investors demand to hold 10-year UK government bonds over similar maturity German bunds widened to 1.13 percentage points last month, the most since 2005 based on closing prices. Both may undermine growth.

Gradual increases

There’s no immediate need to raise rates, Carney said on 25 January at the annual meeting of the World Economic Forum in Davos, Switzerland. He added that any eventual increases will be gradual.

With Britain expanding 1.9% in 2013, matching US growth, money managers are switching their focus to when key central banks will start tightening policy.

The Fed, which has a dual mandate of price stability and full employment, said last week it probably will keep its target rate near zero well past the time that unemployment falls below 6.5%, especially if projected inflation remains below its longer-run goal of 2%.

Joblessness dropped to 6.7% in December from 7% the previous month; part of the reason for the decline is Americans who are giving up on finding work. Prices rose at a 1.1% annual pace in December, according to the Fed’s preferred inflation gauge.

Single mandate

The BOE focuses on achieving price stability in the medium term by meeting its 2% inflation goal. Last month was the first time since November 2009 that price growth cooled to that level after hitting 5.2% in September 2011.

Weak inflation prompted the ECB to cut its benchmark to 0.25% in November, and Draghi said in Davos the central bank would be willing to act against deflation or unwarranted tightening in short-term money-market rates. The ECB’s Governing Council meets the same day this week as the BOE.

In Japan, nineteen of 36 economists surveyed by Bloomberg last month see the central bank expanding already unprecedented stimulus in the first half of this year as officials aim to drive Asia’s second-biggest economy out a 15-year deflationary malaise.

The yield difference between UK and German 10-year bonds widened one basis point to 1.06 percentage points as of 11 a.m. London time, after reaching 1.13 percentage points on Jan. 28.

Strong growth’

The pound slid for a fifth day against the dollar after a purchasing-management survey showed manufacturing growth slowed last month. ING Bank NV economist James Knightley said the report, by Markit Economics, remains consistent with very strong growth, with domestic demand and export orders both improving. The UK currency fell 0.6% to $1.6341 as of 12:48 p.m. London time. It reached $1.6668 on 24 January, the highest level since April 2011.

The market is pricing in that the BOE will raise rates first, and the Fed will follow three to six months after, said Jamie Searle, a strategist at Citigroup in London. The ECB, if anything, is going in the other direction. This will build on the policy-rate divergence that we’ve already seen, which will lead to an unprecedented decoupling in bond rates.

Such a split has drawn criticism from emerging markets, some of which have been roiled in the past month after the Fed’s announcement of a reduction in its monthly bond purchases combined with signs of a slowdown in China to unnerve investors.

Broken down’

International monetary cooperation has broken down, India central bank Governor Raghuram Rajan told Bloomberg TV India on 30 January. Industrial countries can’t at this point wash their hands off and say we’ll do what we need to and you do the adjustment.

There’s precedent for the BOE to take action ahead of the Fed. The Monetary Policy Committee raised its benchmark in November 2003 and again three more times before the US central bank boosted the rate on overnight loans among banks in June 2004 for the first time in four years. That action helped push sterling up about 9% against the dollar.

Between 2007 and 2011, policy makers in London lagged behind their American counterparts in cutting rates and adopting emergency policy measures in response to the financial crisis.

Traditionally, Fed and BOE policy are quite closely synchronized, but if current trends are maintained, then there will be more than enough data and evidence to justify a BOE increase, said Stuart Green, an economist at Banco Santander SA in London.

Housing boom

UK mortgage approvals rose in December to the highest level in almost six years as a revival in the housing market bolstered the economic rebound. Consumer confidence has improved, and Chancellor of the Exchequer George Osborne hailed signs of a manufacturing pickup in a speech last month.

“The BOE should welcome the opportunity to have a small normalization from an emergency policy setting which isn’t really justified anymore", Green said.

Carney’s credibility is under pressure after official data show the UK jobless rate fell to 7.1% in the three months through November from 8.4% in the quarter through November 2011. That’s on the verge of the 7% he and colleagues identified last August as a threshold that would trigger a discussion about higher interest rates—something they initially didn’t anticipate would happen until 2016.

Price pressures

Carney does have more flexibility now that inflation is back to the 2% target. The risk is if unemployment keeps declining, price pressures may re-emerge, especially if joblessness is dropping because of sluggish productivity. Output per hour slid in the third quarter and may leave the economy less inflation-proof.

“We do not believe the MPC can ignore the data and delay", said Philip Rush, an economist at Nomura in London, who forecasts a rate increase in August. “Surging job creation is lowering unemployment without a commensurate supply-side improvement, so spare capacity is being rapidly used up. This is what matters to the BOE". BLOOMBERG

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Published: 04 Feb 2014, 05:47 PM IST
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