BoE: Weak GBP can be the reason to hike other than inflation - Nomura

Richard Koo, chief economist at Nomura, points out that the Fed, BOE, and ECB have all begun a major shift in monetary policy without waiting for inflation to reach their 2% targets and inflation in the UK has in fact risen to 2%, but this is due largely to Brexit-inspired currency weakness rather than to a strong domestic economy.

Key Quotes

“On the other hand, the UK is unique among these economies in that for the first time since the bubble collapsed in 2008 its private sector is now running a financial deficit, currently amounting to 1.73% of GDP. This means the British private sector has finally resumed borrowing, and unless the central bank quickly normalizes monetary policy this could lead to unpleasant acceleration of inflation.”

“Until now, there were few adverse effects from leaving massive quantitative easing policies and ZIRP in place (with the exception of the mini-bubbles described above) since there were no private-sector borrowers and the money multiplier was zero or negative at the margin.”

“But once the private sector resumes borrowing, the money multiplier will turn positive at the margin, and leaving massive amounts of excess reserves in the market under such conditions would enable almost limitless credit creation. Hence the monetary authorities cannot allow this state of affairs to continue.”

“Another reason why the BOE moved quickly to hike rates is probably that the scale of quantitative easing in that country was larger in relative terms than in the US or the eurozone. As a percentage of GDP, the BOE’s quantitative easing was roughly twice the size of the easing programs carried out by the Fed or the ECB, which means a return of borrowers to the market would have that much larger impact.”