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Green shoots?

The move itself was neither large nor unexpected. Rates are just back where they were before the referendum. Recent questioning of the wisdom of such a move while real wages are shrinking, notwithstanding that the Bank had more or less committed itself to raising rates in August, it would have needed some transparently bad news for the Bank to have been able to back track gracefully.

The reaction was also not huge, but it was unexpected. Normal expectations are that a rate rise strengthens the
currency and moves longer term rates up. The opposite happened. The pound fell about 1% while bond yields fell
by about 0.1%.

It’s true that markets had adapted to the move since it was suggested in August but there seems little reason to suppose that they were allowing for a bigger move. If the Bank’s actions can’t be blamed, attention turns to the Bank’s words and, as this meeting coincided with the release of the Quarterly Inflation Report, there were plenty of those.

Prime suspect was the absence of an equivalent sentence to one which appeared in the August iteration, suggesting the Bank was expecting more raises than the market appeared to be discounting. That’s quite easy to interpret as a dovish signal but quite explicit commentary later from deputy governor, Ben Broadbent, suggests this was not an intentional message.

Another notable item, in the report, was a reduction in the Bank’s assessment of its own Goldilocks-just-right rate of growth to 1.5%. This is gloomy news but mixed in terms of rates. On the one hand, the reduction, if the assessment was accepted, might be expected to feed through directly to long term interest rates. However, it would also mean the Bank’s trigger finger is itchier than previously thought. For example, it means that the current growth rate of 1.7% per annum means that the economy is running a bit hot. Either way this does not seem like an obvious trigger for the move.

One further possibility lies in the reasons given for dissent by the two no voters. The Bank officially expects real incomes to start rising very soon and preventing this growth from running away is one of the main reasons for raising rates. It is also an issue on which the Bank’s forecasts have cried wolf for a decade and the dissenters do not think the labour market is yet strong enough to justify a move. Market assessment of labour market conditions agreeing with the dissenters might account for the reaction. There is no clear signal of either strong wage growth or real weakness in labour markets, but indicators that might, with hindsight, be seen as the first sign of either, are out there.

In summary

A small raise was expected and happened. While small, the currency and medium-term yield reaction was the opposite of what was expected to happen, perhaps because there was no accompanying change in the core outlook.

On behalf of our clients, we have reviewed our core asset allocation and the basis on which we project future asset returns and, while we continue to monitor, are not suggesting any change outside our normal review and update cycle.

 

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