The Bank of England’s latest update on the economy is just out, and the upshot is that the UK’s differences with the Federal Reserve are widening.
You can check out the video of the press conference here. I asked Governor Mark Carney about how the UK recovery compared to the US, and I wasn’t completely satisfied with the answer I got (it’s at about 50:20).
All I really wanted to know is why the UK and US central banks are now viewing the global drop in inflation so differently.
Carney said that the US recovery was more advanced than the UK’s (that’s true) and that UK monetary policy didn’t just follow the US (that’s also true). But what I really wanted to know was why the UK and US now have such different attitudes to current low inflation, caused primarily by oil prices. The Fed looks set to raise rates in the next six months, whereas the BoE looks likely to wait a year or longer.
The British and American central banks had very similar responses to the financial crisis, and the recessions that came afterwards.
In December 2008 the Fed cut its main interest rate to 0.25%. The UK followed with its final cut in March, leaving its main interest rate at 0.25%. Both central banks launched QE programmes within months of each other, and kept on enlarging those schemes (buying more and more financial assets) as conditions required.
Both economies have had pretty similar labour market recoveries for the past three years, too. Unemployment in the UK was 8.2%, and it was 8.3% in the US. Now, unemployment is at 5.8% in the UK and 5.7% in the US.
But the two central banks are no longer looking in the same direction. The Federal Reserve is still basically expected to hike interest rates in June, despite tumbling inflation coming from much lower oil prices.
In comparison, the Bank of England (which now expects no inflation at all, or even deflation during the summer) is suddenly willing to wait a lot longer. Markets suggest the BoE will wait another year before hiking. Carney said the positive and negative risks were about balanced, suggesting that there’s a significant possibility the UK could even have to cut rates further or do more QE.
This is new: Back in August last year an economist poll by Reuters suggested the UK would hike first, and for a lot of last year markets were pricing in the same thing. Now it looks like there’s almost no chance of that.
The Bank of England seems perfectly happy to sit on its hands while inflation is below target: It may hike rates at the beginning of next year, but since it doesn’t expect that inflation will go back to 2% until 2018, it’s in no rush.
This slightly complicated chart tells the story:
Forward rates just mean what markets expect interest rates to be in the future. If you look at the blue and pink dashed lines (which is what markets expected in early November), you can see the BoE’s line (blue dashes) rising a little bit earlier than the Fed’s (pink dashes).
If you look at the solid lines (what markets expected about a week ago), it’s changed. The Fed’s line (pink solid) now rises earlier than the BoE’s (blue solid). US interest rates are above UK interest rates for almost all of 2016, the exact opposite of what was expected last year.
It’s not entirely clear why the Fed and BoE have split so sharply on this. Last year Carney said that the BoE might hike rates sooner than the market expects, and Fed chief Janet Yellen was being described as incredibly dovish by almost everyone. But now it looks like Carney isn’t much interested in raising rates at all, and by all accounts Yellen is getting ready to do just that.