Can Carney convince the markets?
The first Bank of England rates hike in a decade left forex investors underwhelmed. With the economy sluggish and wage growth limited, John Wraith of UBS tells Roger Blitz why BoE governor Mark Carney is risking a policy mistake
Presented by Roger Blitz and produced by Fiona Symon
Welcome to Hard Currency, the Financial Times podcast on the foreign exchange market. I'm Roger Blitz, and this week we have three big market moving events. We have the Bank of England rate hike, the first in 10 years, the White House's attempt to get a tax reform programme up and running, and Donald Trump's appointment of the next Federal Reserve chair. With me to discuss all these is UBS strategist John Wraith. John, first of all, the BEO, the market reaction, I mean if the bank was trying to deliver a hawkish hike, then the sell off in sterling, fall in gilt yields, market expectation of future rate hikes being pushed out suggest they haven't quite got it right, have they?
Well certainly not in the initial period after the hike, no. And we've obviously had the press conference where they've tried to explain their rationale and their forecasts and so on. And as you, say gilt yields have fallen significantly on the day. That hasn't happened in other markets, it's very much a UK specific move. And sterling has certainly sold off quite hard as well. So it does, as you suggest, mean that the market has taken this in a more dovish way. We knew the hike was coming. It was priced in with close to 100% certainty. It was all about the message as to what lies beyond, and I think as we sit here, we must assume that the future amount of tightening is actually likely to be less than we'd previously anticipated.
So one and done, quite possibly?
Quite possibly. And what they've done, interestingly, here is made it what we would term much more data dependent. This hike was always more about-- or partly about the data, of course, but also a determination by the MPC. A sort of willful hawkishness to try and get rates a bit higher. They wanted to deliver a hike. Now they've basically said, having done that, we are going to go back to a situation where we only base our future views on the data. And their views, in many eyes, are somewhat optimistic. So if they don't come through, it's going to be hard for them to hike further.
What is the evidence for this being the start of a rate hike? I mean, they talked about an interesting shift in the economy from consumption to investment and exports. They talk about signs of wage growth. And they also talk about the idea that actually we need further rate hikes in order to get to inflation target. Is all that reasonable?
Well, there's good reasons to think some of these things may occur. I mean, the unemployment rate is at historic lows. Inflation is above target at the moment. And if wage inflation comes through, then there will be some clear evidence that the economy is tightening up. However, in our view, that wage inflation is not materialising yet. Now it might. If it does, this hike will probably become the first of a cycle and be seen as reasonably prescient. If it doesn't, then I think it may be that this comes to be seen as a policy mistake because they're squeezing consumers who are already suffering through negative real earnings. And if wage inflation doesn't pick up, those real earnings are going to persist.
Yeah. That was an interesting question he was asked, Mark Carney, about is this rate hike like other rate hikes around the world? He was saying, well there's global growth around the place, but actually the UK economy-- yes, it's growing, but it's growing quite sluggishly.
We were looking at an analysis earlier of this, and if you look at the composite PMI indices, which are reliable leading indicators of growth that are looked at and have long historic track record. Since the start of this year, that's slowed down in the UK. And you look at almost any other of the Eurozone economies, the US, Canada, the big G7 economies, it's accelerated. Growth's been accelerating elsewhere, particularly in the Eurozone, of course, while it's been slowing in the UK. So there's something going on in the UK which isn't seemingly happening elsewhere. And of course, most roads so often lead to Brexit in many people's views. And most views about monetary policy, about the outlook for the UK economy do incorporate an expectation of how Brexit will play out over the next year or two. If you're optimistic about it, then the UK can arguably participate in this global growth cycle. If you're more pessimistic, then the UK does look uniquely vulnerable at this point.
Yes. It's slightly invidious to compare economies, but we had the great cintre pact earlier this year in which the idea was to retreat from qualitative easing. And yet that seems to be very good on paper, but in practise it seems to be quite hard. For example, Canada has had a pretty poor economic data out this week and perhaps they are now heading towards caution. We had the ECB last week, which came out with a very dovish taper, which actually sold off the euro, much the way that the pound has sold off today.
So is that whole idea about taking the foot off the QE pedal just becoming more difficult?
Well, I think in defence of central banks, I think it's understandable from a policy desirability point of view to want to and normalise things. However, of course-- as you're implying, and quite rightly so-- the economies that we're talking about need to be strong enough to tolerate that reduction in accommodation, or tightening in the case of a few central banks. And the jury's out. I mean, clearly, the US, for example, is performing better and has been able to withstand 100 basis points of rate hikes without too much difficulty.
The eurozone is certainly performing well economically, even though as you say, the tapering hasn't even begun yet. But in the case of the UK, you can't go down this coordinated route if your economy doesn't justify doing so. And I think what we've seen today is an attempt by the Bank of England to step in that direction of tightening or less accommodation, but a market perception that in doing that, you're not setting policy appropriately for your own domestic circumstances.
And you talk about the UK economy being data dependent, but in fact, as Carney was saying, it's Brexit dependent, isn't it?
Well, it has to be. And they do acknowledge that. They're in a difficult situation. They can't comment too explicitly on their expectations around Brexit, so they say, we base our view or we assume that households and businesses will base their decisions on an expectation of a smooth transition. And if that happens, and certainly if we have details of that transition sooner rather than later, then there's grounds for optimism in the UK.
But UK politics is looking murky again, very difficult for Theresa May. Do you think that's going to weigh on sterling? Well, yes. But by extension, because it does make life more difficult in the Brexit negotiations, they're very reliant on all their MPs because of their lack of an overall majority. And of course, there are possible ways in which the government could come under pressure and fresh elections could happen sooner than currently scheduled. And of course, just based on the opinion polls, we could get a material change of policy under a new government.
So again, for businesses trying to plan investment decisions, for consumer confidence, and so on, if you don't know with certainty what sort of fiscal and political regime you're operating in, it makes it a lot more difficult.
Sterling is also going to move because of the dollar, and the dollar is clearly coming under pressure from this appointment we expect of Jerome Powell at the Fed, but also with the tax reform plan is once again coming slightly [INAUDIBLE] being so watered down as to be not significant enough. Where do you see the dollar going, John?
Well, in the longer term, we are bit negative on the dollar, partly because the US is further through its cycle, and as we were saying before, the eurozone, for example, hasn't even begun to reduce accommodation yet. So we think the euro will continue its recent strengthening against the dollar into the medium term. I mean, I think the appointment of the Fed chair actually we think is a source of some comfort because in such uncertain times to have the continuity of someone who's been at the Fed for a while, who has never dissented, who has been part of the sort of mainstream view is pretty reassuring.
Is Powell basically Janet Yellen-like?
Well, I mean, I'm sure he's his own man. But he certainly hasn't developed a reputation as being particularly hawkish or dovish. He's toed the line. He's obviously got his own views and no doubt, they'll develop over time and he'll put his own mark on the Fed. But for now, he's seen as someone who's relatively predictable compared to some of the other names that were floated around and therefore, I think the markets are probably pretty relieved because they've got enough to worry about, enough uncertainty. And as you mentioned, the tax reform is one of those.
[INAUDIBLE] the market just sanguine about tax reform?
Well, I think we've seen under the current administration that the course of policymaking doesn't necessarily run smooth for a variety of reasons and it isn't necessarily clear. Clearly, there's a desire for significant tax reform, but as with so much else, it has to find its way through Congress and the Senate; it has to deal with vested interests of one form or another. And only when we get to the end of the road will we really know what's coming. And until then for markets, it's very difficult to assess.
OK. So you're bearish on the dollar?
Yeah, mildly so, we are.
Bearish on sterling?
Yeah. Constructive on the euro.
Constructive on the euro. And anywhere else that you like the look of?
I mean, those are our sort of main views among the major global economies. Japan's obviously been performing reasonably well, as well. But our sort of main view in currencies is that we do think this euro strength that we've seen over the course of this year as the eurozone economy has performed, albeit with the help of significant monetary accommodation, but has performed beyond most expectations and continues to do so. As long as the ECB can tread that tapering road without stumbling, which is not certain but certainly we hope and expect to see, then we think the euro can strengthen further.
And as long as Spain is kept in check in the political world.
There are strains out there which might get exposed, of course, as policy is normalised. Because these cracks are easier to paper over when conditions are very benign, and clearly the ECB's policy, for example, of buying very large amounts of peripheral eurozone debt has masked some of the ongoing structural strains within certainly the eurozone and arguably the wider EU. So time will tell whether the gradual winding back of that accommodation brings those stresses back into focus or not.
OK. My thanks to John Wraith of UBS. So next week we'll have further reaction to that Fed appointment; we'll be looking at Asian currencies as Donald Trump tours the region; and of course, we have the resumption of Brexit negotiation. So join us again for "Hard Currency." Goodbye.