This morning, the Bank of England released its minutes from the September meeting of the Monetary Policy Committee. From my reading, it contained no new news on the prospects for negative interest rates. The “relief” from the minutes has so far lifted the pound against the euro, the U.S. dollar, and even the yen. I am scaling back into short positions versus the pound in anticipation of a relief rally in the dollar (one that lasts more than the 2-day pop that Tuesday’s moves completely erased!) and/or a significant correction in the stock market. I am also maintaining a position long EUR/USD as a small hedge.
In the summary of financial markets, the BoE noted the continued drop in interest rates as riskier asset prices generally increased. The Bank’s read on the international economy was mixed. On the positive side, the Bank noted China’s strength and a sharper than expected recovery in the euro-area. On the negative side, the Bank warned that an export-driven recovery in China would exacerbate global economic imbalances and “vehicle scrappage schemes” (cash for clunkers in the U.S.) may not lead to sustainable economic recoveries.
The BoE was encouraged by an uptick in the money holdings of the non-financial private sector. Such an expansion should, of course, lead to stronger consumption in the U.K. However Q2 consumption contracted more than expected. This has led the BoE to conclude that “the Committee should perhaps be cautious in drawing inferences about consumption from strong retail sales and car registrations.” In fact, credit availability to the non-financial private sector shrank and “the pressures on banks to shrink their balance sheets had continued to impose monetary restraint on the economy.” These dynamics support continued easy money policies from the BoE.
Most interesting to me is the way in which the BoE wrestled with the issue of inflation and inflation expectations. In particular, “CPI inflation excluding the contributions of food and energy prices had remained stubbornly high over a number of months, despite the large degree of economic slack that the Committee believed had opened up in the economy.” The BoE offered two potential explanations for these data. Either estimates of slack in the economy are too low or inflation expectations are well-anchored to the 2% CPI target. Since it cannot distinguish between the two explanations, the BoE concluded that they will have no impact on current policy decisions. In my opinion, “punting” on this issue leaves open the prospect of a big (upside) inflation surprise in the not-so-distant future.
Finally, the BoE expects the CPI inflation data to be extremely volatile in the coming months. This volatility includes uncertainty over price cuts from utilities (now appearing less likely) and changes in taxation. Although near-term inflation levels are likely to be higher than expected, the BoE expects no overall impact on the medium-term outlook for inflation. In particular: “Although the data on output growth were more encouraging, the level of output had fallen significantly and there was likely still a large measure of spare capacity in the economy. Moreover, even if GDP growth had turned positive in Q3, it was unlikely to have reached the point where the level of spare capacity was shrinking. Unemployment continued to rise, and was likely to continue increasing for some time. Growth in private final domestic demand, which was essential for a sustained recovery, had been weaker in 2009 Q2 than the MPC had expected at the time of the August Inflation Report.”
All in all, the Bank of England appears to be looking hard for reasons to remain stimulative, so easy monetary policy will continue for the foreseeable future.
Be careful out there!
Full disclosure: short GBP/USD, long EUR/GBP and EUR/USD, short GBP/JPY.