An Unreliable Boyfriend:

Sadly, Dr. Mark Carney looks like he’s in for another round of being labelled the unreliable boyfriend. Accusing markets of significantly under pricing the probability of a rate hike and claiming that the Bank views the UK economy through far more sanguine eyes than the market at large, the central bank Governor looks highly likely to perform a U-turn on later today.

 

 

Through gradual coercion, the Bank of England principal and his peers led market participants to believe, and price in, the progression of this adolescent phase of monetary policy tightening. Signalling that the UK economy was gaining strength and proving resilient following a lost decade of growth, the Pound rallied strongly. The change of environment was pivotal in the bid to stem a bullish run towards GBPEUR parity: a paradigm where one Pound Sterling would be worth one Euro. Tangibly, the expectations led global investors to believe that the reward for saving and investment in the UK political economy would rise, manipulating asset allocation as the cost-benefit matrix of reward vs. safety began to tilt in the developed economy’s favour.

 

As a result of Carney’s teasing, markets came to price in a 25 basis point interest rate hike at the Bank’s next monetary policy announcement on Thursday, so much so that it became the dominant and semi-infallible expectation. However, data looks to have forced the Bank into an impossible position, where a hike would be seen as irresponsible and harmful to the public that the monetary policy instrument is ultimately there to serve.

 

A slurry of data over the last two weeks has diminished the probability of a hike this afternoon. As discussed in last week’s publication, consumer price inflation data, purchasing managers’ indices, and gross domestic product readings have all cast a shadow over the short-run economy. Now, adding to the inhibition to higher rates, it seems there’s just not enough money to facilitate a hike!

 

Whilst I certainly don’t possess the market manipulating power of leviathans such as the (in)famous Robert Peston, I should caution that a run on the banks is not necessary at this point; the Bank of England is one of a finite handful of institutions that has a genuinely infinite amount of money. Instead, it is the UK public that can’t put its money where Carney’s mouth is.

 

Statistics measuring all sorts of permutations of ‘money’ were published earlier in May, and the results weren’t pretty. The numbers were remarkably weak, showing a stagnant growth of ‘M1’, or to you and me, smaller numbers in bank accounts and less notes and coins loitering on the counter, our pockets and under the sofa. In fact, after taking (admittedly rampant) inflation out of the equation, the real growth of this tangible form of fiat money has fallen to zero. However, following the decline of monetarist central banking after the a posteriori falsification of Milton Friedman’s monetarist economics that dominated the 80s, monetary policy is now relatively ignorant of readings of the money supply. So what problems does this create?

 

Well, even if we skip (as I shall) the socialist suggestions of an inevitable conclusion to the capitalist market structure as infinite desires fail to be satisfied in a zero-monetary growth paradigm, the implications remain significant. So long as M1 – normal money – remains subdued, the Bank will face considerable criticism not to raise rates.

 

The reason is simple: markets facilitate the pulling forward of future wealth and income for immediate consumption – a mortgage, car finance and a fiver from a non-philanthropic friend all perform the same fundamental function – disposable income now at the (tacit or explicit) promise of future repayment when circumstances permit or expectations make profitable. At times of low money growth, people still want, desire and need ‘stuff’ – all of which costs money. People therefore need to drawdown money from their future for present consumption in order to sustain and maintain their present level of utility.

 

The satisfaction of the public is highly significant to any government that retains the fundamental desire (supposedly and hopefully) to stay in power. An unhappy public leads to political change as dissatisfaction manifests as resentment towards the incumbent government that failed to satisfy and maintain their desires and expectations.

 

Whilst independent from the government, the Bank of England is a public institution with a mandate from the government and a weak and shrouded, but unmistakable, interest in politics. Therefore, despite having an almost exclusive mandate for price stability, it should care about people and the income and financial conditions they face. From a holistic monetary economics point of view, the Bank could even justify maintaining the status quo as a defence from political upheaval and the spill over effects within the domestic economy.

 

Following this final blow to domestic monetary policy expectations, the Bank is now largely expected to keep interest rates on hold. Unless Carney, the previously unreliable boyfriend, delivers an immense and purely symbolic gesture to flaunt the strength and resilience of the economy, he and the monetary policy committee will once again face jesting taunts. Moreover, any positive latent expectations behind a hike will be priced out, resulting in a potential devaluation of the pound. The reaction to the stubborn hike, much like the partner’s reaction to the boyfriend’s pointless and ostentatious gesture, is likely to be highly mixed at best.

 

The reward for investment and vote of confidence would generate a bid behind the economy, however, the irresponsibility behind the decision might flatten the future curve and mute the expectations for subsequent hikes as the public reel from the hike. Perhaps more important than the decision itself (particularly in the face of a no-hike decision), will be the forward guidance of the monetary policy committee concerning the future path of tightening.

 

P.S. oh yeah, Brexit.

 

 

 

Discussion and Analysis by Charles Porter

 

 

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