The Governor-elect of the Bank of England Mark Carney has been testifying to the UK Treasury Select Committee this morning and so far his testimony suggests he will be a pragmatic Governor, who won’t adopt radical changes at the Bank, but will implement subtle changes that could impact how policy decisions are made in the years ahead.
At a speech in December, Carney caused a media storm when he said that central banks could start targeting GDP (rather than inflation). Since the UK economy is contracting, this could mean further rounds of monetary stimulus. However, Carney has clarified his comments today and said that the bar to changing from an inflation targeting regime to a GDP target is very high, and instead he proposes that the BOE follows the Bank of Canada by reviewing the policy frame work every 5 years. Since Carney’s term is only 5 years (down from the usual 8), any change is policy framework might not even happen under his tenure at the Old Lady.
A smooth transition at the BOE
Carey’s pre-prepared statement, released at the same time he started to testify, espoused a flexible inflation targeting regime that took into account the macro-economic environment. This seems similar to the BOE’s current stance – as the economy has been weak over the last 5 years and QE has been pumped into the system, inflation has run above target. Thus, could it be more of the same from Carney?
In truth, today’s testimony was probably over-hyped as there is very little juicy detail he can reveal (like if he would vote for more stimulus etc) without even chairing a meeting. Added to that there is a BOE meeting going on today. The only colour we received on this topic was when he said that he wouldn’t mind voting in the minority while Governor of the BOE.
Carney neutral not dovish
Overall, as we mentioned in yesterday’s Fundamental Update, Carney has not been as dovish as expected and his comments don’t suggest that the monetary taps will be turned on the moment he takes up his new job in the summer. As we mentioned yesterday, maybe it is coincidence, but when Carney was announced as the new Governor last November it corresponded with the peak in GBPUSD above 1.63. While we don’t believe there is a direct link between Carney taking over the BOE head’s job and the pound, Carney’s less dovish than expected comments today could have a big impact on the 5-year UK Break even rate (the difference between the yield on inflation linked bonds and regular Gilt yields). Interestingly, the yield has continued to widen, suggesting that there is demand for inflation-protected debt even if Carney may not be as dovish as some expected. However, yields could moderate in the coming days as the markets digest Carney’s comments.
The markets caught on the back foot
The pound immediately moved higher on the back of Carney’s early comments that the BOE “must exit” unconventional policy measures. This left the markets on the back foot, as much of the recent coverage about Carney has been in relation to easing and more stimulus. We believe that an “exit” from stimulative monetary policy is years away, especially with the economy being so weak and Carney was simply avoiding any concerns that he could monetize the UK’s debt.
GBPUSD immediately jumped on the commentary, reaching a high of 1.5750. 1.5670 is the low so far today. Overall, Carney’s comments were fairly neutral for sterling in our view. He didn’t get involved in currency wars, and said that a central bank should only intervene in their currencies as a last resort. We continue to think that a short term low is in place just below 1.5600, while 1.5750 may be a short term top. The better than expected production data for the UK for December was broadly ignored by the market. However, it may be important for sterling down the line, especially if it signals that Q4 GDP could be revised higher as production was the weakest link in the initial estimate.
Spain’s political woes cost Madrid at auction
Earlier, Spain held a bond auction. Demand was solid but yields moved higher, possibly as a result of the political unrest. However, there was some good news; today’s sale means that Madrid has sold 18% of its full year medium and long-term funding target for this year already.
Can Draghi argue that things are still stabilising in the currency bloc?
Ahead today, the ECB is the chief focus. Draghi’s press conference at 1330 GMT is the highlight. It is likely to be the most interesting press conference for a while as Draghi may get questioned about the recent political rhetoric over the strength of the euro. With Spanish and Italian yields higher than they were at the January meeting, it will be harder for Draghi to justify that things are continuing to stabilise in the currency bloc. Any sign that he is concerned sovereign fears could flare up again or that there could be further ECB policy waiting in the wings, could be euro negative in the medium-term. That would be the bigger shock to the markets, as most people expect a fairly tight-lipped Draghi today, who will stick to using a fairly hawkish tone. Since EURJPY is very sensitive to sovereign risk, we could see this cross come under substantial downward pressure if Draghi is dovish later today.
One to watch: Just in case Draghi is on the dovish side….
We only think there is a slight chance of this happening, but if it does then EURJPY could come under downward pressure. It has moved higher today, along with other EUR crosses, but two things are worth pointing out: 1, 127.80 looks like key resistance in the short term, and 2, the hourly RSI is close to overbought territory at 66. Support lies at 127.10 then 126.60 – a cluster of hourly smas.