Two weeks ago, Bank of England governor Mark Carney confidently said that the vote to leave the EU would lead to “a materially lower path for growth” and that “some monetary policy easing will likely be required over the summer”. Earlier today, the Monetary Policy Committee (MPC) decided to do nothing. What happened?
Wait And See. The answer is that the MPC sensibly decided to await further evidence before taking action. Ahead of the decision, market economists were divided almost equally between no change and a 25 bps interest rate cut. The former was a wait-for-the-evidence view, the latter a vote for early, decisive action.
The minutes suggest that the MPC still expects a distinct downturn in the economy but the signals so far are tentative. Business and consumer surveys have indicated a sharp fall in confidence but that was to be expected. The fear – not articulated in the minutes – is the chance of a bounce-back in sentiment. The committee would look foolish if it cut rates in July only to reverse the move a few months later.
The Banks’s Agents may also have had an influence. The minutes reported that one-third of contacts expected weaker capital spending ahead: one would have expected a greater proportion. In addition, the agents said that there had been “no clear evidence yet of a sharp slowing in activity”: in other words, businesses are worried but not cutting back just yet.
Do The Math. The MPC also stressed that it wanted to wait for a fresh economic forecast due in August. This will allow access to better data and also give the opportunity for proper reflection. The next Inflation Report is due to be published in three weeks’ time on Thursday 4th August.
It is pretty certain that the Bank will lower its growth forecast and (thanks to sterling’s decline) raise its inflation projection. However, there may be a better sense whether the downturn will be sudden and pronounced or slow to materialise and mild.
Other Reasons For Delay? Here are two. One, the markets have already done some of the Bank’s easing for it. Sterling’s trade-weighted index is down roughly 9% since end-May; short rate expectations have fallen some 25-30 bps since just before the referendum; and 10yr gilt yields are down about 50 bps. These moves make Bank of England action less urgent.
Two, the old market adage that it is better to travel than to arrive remains true for monetary policy. There is a sense in which, for now, the prospect of monetary easing is just as effective as actually cutting rates. But in three weeks’ time either economic conditions will need to have improved or the Bank will have to deliver.
Market Implications. The immediate response to the Bank’s inaction was a stronger pound, higher short rates and bond yields and a weaker equity market. The key point, though, was the reasonably measured response. The markets still expect the MPC to act in August but it seems that the markets are calmer than Mr Carney.