MUNIX COMMENTARY – 18th November
Water off a duck’s back
There has been considerable criticism of the Bank of England following its decision in November not to raise interest rates. Part of this reflects a debate amongst economists about how a central bank should best communicate policy in the modern world. For example should the MPC follow the Federal Reserve’s approach and produce individual forecasts for each MPC member? A second set of criticism is more self-serving. This was largely from hedge funds and other trading investors who made sizeable losses in recent weeks as they were the wrong side of the MPC’s surprise announcement.
Central bankers are used to such commentary, and the best of them are well versed in providing a considerable degree of nuance or stonewalling when necessary. Much can be learned from the masters, such as the warning from Fed Chair Alan Greenspan: “I guess I should warn you, if I turn our to be particularly clear, you have probably mis-understood what I have said”
On other occasions, the central bankers are pushing at an open door. This week, Bank of England Governor Andrew Bailey met the Treasury Select committee, explaining that he was very uneasy about inflation and that his decision to keep interest rates on hold in November had been a very close call. A few days later two sets of economic statistics strongly encouraged investors to consider that the MPC will act on December 16th. Headline inflation for October at 4.2% year on year and core inflation ex good and energy at 3.4% were a little higher than expected. The well-advertised path towards a 5% peak this winter looks in place. The labour market data showed continued strong demand for new workers, with average earnings growth running about 4-5% from a year ago. As a consequence the benchmark 10-year gilt yield moved higher towards 1%. UK financial markets are pricing in an increase in base rate from the current level of 0.1% to over 1.0% by the end of 2022.
Of course, on some occasions the markets prefer not to listen. Christine Lagarde at the ECB made another statement saying that she thought it unlikely that the conditions would fall into place for the central bank to act next year. She and other European policy makers were probably not best pleased when someone as senior as Deutsche Bank chief executive Christian Sewing warned that inflation was producing risky side effects and would last longer than policymakers expected. Economists continue to boost their EU CPI forecasts for next year past 2%, and expect a rate move next autumn.
Markets also pay attention when a new central banker appears on the scene. How to interpret their language, how hawkish or dovish, how independent or political will they be? In this respect, an interesting decision could appear in a few days, when Joe Biden says he will announce his pick for chair of the Federal Reserve. Jay Powell’s term expires in less than three months. Will Biden re-appoint him or choose Lael Brainard, a governor who has the backing of progressive members of the Democratic Party for her more stringent stance on regulatory matters? Many in Congress have an intense focus on inflation as rising prices are becoming a political liability. If there is new hand on the tiller their words will be listened to with even greater interest.
Andrew Milligan is an independent economist and investment consultant. This note is offered as general commentary on economic and financial matters and should not be considered as financial advice in any form.
Andrew Milligan an independent economist and investment consultant. From 2000-2020 he was the head of global strategy at Standard Life/Aberdeen Standard Investments, analyzing the major financial markets for global clients. He currently assists a range of organizations with reviews of their investment processes, advice on tactical investing and strategic asset allocation, and how to include ESG factors into their decision making