Thursday, July 4, 2013

BOE holds rate, QE, rise in bond yields weighs on outlook

    The Bank of England (BOE) maintained its Bank Rate at 0.5 percent and its target for asset purchases at 375 billion pounds, as expected, but added the recent rise in market interest rates would have a negative impact on its outlook for economic growth and inflation, and it did not consider the implied rise in its policy rate to be warranted by economic developments.
    The BOE, which has held rates steady since March 2009, said recent data had been largely consistent with its outlook for growth and inflation from May and inflation is expected to slowly fall back towards the bank's 2.0 percent target though it may rise further in the near term.
    But the BOE's Monetary Policy Committee, chaired for the first time by Governor Mark Carney, voiced concern over the recent volatility in asset prices and higher bond yields.
    "The significant upward movement in market interest rates would, however, weigh on that outlook; in the Committee's view, the implied rise in the expected future path of Bank Rate was not warranted by the recent developments in the domestic economy," the BOE said.
    Carney took over on Monday from former Governor Mervyn King who retired. Normally, the BOE does not issue a statement when it maintains its policy stance though it has on occasions issued statements when it wants to convey a message to markets.

    Yields on government bond yields in the U.K. and U.S. have risen in recent weeks following better UK economic data and Federal Reserve Chairman Ben Bernanke's statement on June 19 that the U.S. central bank is considering slowing down its asset purchases later this year.
    The benchmark U.K. 10-year gilt was trading around 2.41 percent today, up from 2.06 percent a month ago with the market pricing in a rise in the BOE bank rate in the second half of 2014.
    But the BOE played down the recent improvement in economic data, saying "signs that a recovery is in train" but "it remains weak by historical standards and a degree of slack is expected to persist for some time."
    The U.K. Gross Domestic Product expanded by 0.3 percent in the first quarter from the previous quarter for annual growth of 0.3 percent, slightly higher than 0.2 percent in the fourth quarter.
    In addition to holding rates steady since the depth of the global financial crises, the BOE has also been purchasing assets, mainly UK government bonds, to hold down interest rates and help stimulate economic activity.
    The last time the BOE expanded its target for asset purchases was in July 2012, when it was raised by 50 billion pounds. In his final five meetings chairing the bank's nine-member policy committee, King failed to convince a majority to raise the target for asset purchases to 400 billion pounds.
    Inflation in the U.K. rose to 2.7 percent in May from 2.4 percent in April, but the BOE expects it to ease back towards 2.0 percent "as external price pressures fade and a revival in productivity growth curbs domestic cost pressures."
    The arrival of Carney from the Bank of Canada to the BOE has been accompanied by expectations that the BOE would provide markets with a guide to the central bank's view of how policy rates would develop over time, known as "forward guidance."
    Today's comment by the BOE on the recent volatility and upward movement in long-term interest rates marks the de facto arrival of such forward guidance in the UK. Carney used such forward guidance at the Bank of Canada.
    Next month, the BOE said it would complete its assessment of the "case for adopting some form of forward guidance, including the possible use of intermediate thresholds" and this would have an "important bearing on the Committee's policy discussions in August."
    Thresholds are used by the Federal Reserve to guide market expectations.  Currently, the Federal Reserve expects to hold its federal funds rate at the 0-0.25 percent as long as the unemployment rate remains above 6.5 percent and that inflation is not expected to exceed 2.0 percent by more than half a percentage point.


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