On Thursday 7th February at 0945GMT/ 0445 ET the governor-elect of the Bank of England, current Bank of Canada Governor Mark Carney, will take questions from the UK’s Treasury Select Committee. The Committee has already said that it will ask Carney about monetary policy tools and if the existing framework for policy is the right one for the BOE, especially since the UK’s economic recovery has been so weak since the financial crisis. These are provocative questions, so will a Bank of England under the stewardship of Carney take the BOJ approach and pledge to do all it can to help boost economic growth?
What Carney has said so far?In a recent speech Carney said that developed world central banks have not maxed out what they can do to boost their economies. He has also said that it is possible for a central bank to target GDP rather than CPI to try and boost growth. This is a big shift from current BOE policy. Firstly, some current members of the BOE have expressed concern that QE (the current policy tool of choice at the Bank) may have run its course, secondly, the Bank still targets CPI. Since inflation is running at 2.7%, above the 2% target, the options for future stimulus under the current regime appear to be fairly limited.
What the market is looking for tomorrow:The market wants to see just how dovish Carney actually is. A dovish testimony may include Carney supporting GDP targeting at the BOE, since GDP was negative in Q4 2012 and the UK is on the edge of a triple-dip recession, this would make further policy stimulus more likely once Carney takes the reigns later this year. If he sounds a more cautious tone, especially around the high level of inflation, then we could see the market react by buying the pound and selling Gilts (pushing up Gilt yields).
We believe there is a chance the Governor-elect will be more neutral than the market expects. He may take the pragmatic route, saying that he will adjust policy according to the economic situation at the time. He may also elaborate on how the BOE could target GDP at the same time as keeping inflation under control. From a diplomatic perspective, we don’t think he will want to ruffle feathers at the BOE before he starts, and since the current Monetary Policy Committee targets inflation he may not want to suggest something completely new to politicians before he has had his first meeting as Governor. Added to that we think that Carney will want to avoid any talk of the level of the pound and its effect on the economy, especially as rhetoric around currency wars has been stepped up of late. Thus, we don’t expect any BOJ-esque comments from Carney at tomorrow’s meeting.
Potential market reactions:When Carney was announced as the next Governor of the BOE in November (he takes up the post in July) it was timed almost perfectly with the top in GBPUSD above 1.63. Since then the pound has fallen more than 5% on a broad-based basis. This decline has accelerated sharply since the start of this year. Partly this decline is down to the dismal economic data, but it could also be on the back of expectations of more monetary stimulus under Carney.
Gilt yields have risen as Eurozone sovereign fears have retreated. Usually expectations of future monetary policy stimulus prompt bond yields to fall; however, Gilts are sensitive to changes in levels of Eurozone sovereign risk, which has had a powerful effect on yields in recent months. However, the “Carney effect “ has been felt in inflation break even rates (inflation linked bonds – Gilts of a similar maturity).The 5-year break-even rate is at its highest level since 2011. This suggests that the markets are pricing in the possibility of liquidity-fuelled inflation during Carney’s tenure at the BOE.
In our view, the bigger risk for GBP tomorrow could be a neutral tone from Carney. While we expect him to comment on the dire growth rates, it will be interesting to see if he thinks the BOE can fix it. If he blames weak growth on external factors, we may see the pound stage a rebound after a hefty sell off since the start of Feb.
From a technical perspective GBPUSD is looking oversold on the daily chart. Added to that, earlier this week a bullish harami daily candle stick pattern emerged (a small green candle follows a long red candle), which suggests that we could see a short-term reversal ahead of 1.56. Near-term resistance levels include 1.5720 and then 1.5795 – a high from last week.
Chart 1: UK 5-year break even rates, at a 2-year high
Source: FOREX.com and Bloomberg
Chart 2: GBPUSD daily