Major central banks on both sides of the Atlantic keep reiterating their respective monetary policy paths are strictly data-dependent, but the increasing risks stemming from their highly divergent positions may very well play an important role in future global monetary maneuvering.
Much has been written in recent months about the risks of divergent monetary policy paths on both sides of the Atlantic, and the impact those diverging monetary positions may have on currencies and fixed-income assets in emerging markets.
The Bank of England (BoE) warned of this earlier this year, when it said: "There was a risk that divergent monetary policy trends, as well as stronger prospects for growth in the United Kingdom than in the euro area, might continue to put upward pressure on the sterling exchange rate."
Mohamed A. El-Erian, chief economic adviser at Allianz (DE:ALVG), wrote in a recent article called 'The Great Policy Divergence' that "the problem is that there may be few, if any, orderly mechanisms to manage the international repercussions of this growing divergence".
Expectations were high ahead of last week's meeting of the European Central Bank (ECB) that the Governing Council would expand monetary easing more aggressively, and thus diverge even more from the US Federal Reserve (Fed) and the BoE. Instead, the ECB remained cautious and eased policy less than markets had been expecting, despite downside risks to inflation.
Thursday this week will see the last meeting of the BoE's Monetary Policy Committee (MPC) this year. The policymakers will most likely keep the base interest rate unchanged in December, with only one rate-setter, most probably Ian McCafferty, again voting for an immediate hike, with the rest of the nine-strong committee waiting for more hawkish data on inflation and growth. Market participants will also seek any clues on the sentiment and outlook in the MPC minutes, due on the same day.
The BoE meeting next week comes ahead of the very much awaited Fed decision on December 16. Central bank aficionados see this meeting as the breaking point in US monetary policy, as Fed policymakers are expected to increase the base rate for the first time since 2006, and then remain slow and gradual in further tightening rounds.
Labour markets in both the US and UK have been tightening sharply in recent years. The jobless rate in the UK has been falling significantly, and hit 5.3% in September, close to the estimated long-run equilibrium rate. But wages remain too weak to help return inflation back to the 2% target in the medium term, according to the BoE. Strong external downward price pressures kept the annual rate of CPI 0.1% below zero in October.
The BoE's latest inflation report, released earlier in November, stated that inflation was projected to start rising over the coming months as the past decline in energy prices start to drop out of the annual comparison at the beginning of next year. However, policymakers also warned that this pick-up in CPI may be lower over the first half of 2016 due to protracted low oil and other import prices. The latest data on Oil prices show the US crude benchmark continued to slump this week, approaching the $39 level, due to the ongoing global supply glut, and following OPEC's failure to reach any production cut agreements on Friday last week.
An increasingly dovish outlook and the recent cautious comments by policymakers have led market participants to push their expectations for the first hike all the way to 2017. BoE Deputy Governor and rate-setting committee member Jon Cunliffe warned last week that such expectations were a bit premature.
Speaking to The Financial Times on Tuesday, Cunliffe said: "The next move [in interest rates], in my view, is up ... I also believe the economy has come out of a pretty wrenching period and a number of the indicators on both the supply and the demand side are much harder to judge than when I was on the MPC as the Treasury observer for five years between 2002 and 2007 ... I think we see signs of pay growth coming back in the economy and we're seeing signs of productivity coming back, but . . . I'm data-dependent."
Even though most rate-setters maintain a more or less dovish stance, the November MPC minutes revealed that "there continued to be a wide spread of views among members about the outlook for activity and inflation, and individual members placed differing weights on the risks from developments in emerging market and the potential influences on domestic demand growth".
Berenberg bank UK economist Kallum Pickering argued in his most recent note that "the Bank of England consistently underestimates the pace of the labor market recovery in their forecasts".
"Latest consumer credit data showing the fastest pace of growth in almost a decade. This adds to our concerns that the BoE is starting to fall behind the curve. This persistent lowballing on key domestic indicators could have implications for the inflation outlook - meaning that there is a risk that inflation may overshoot the 2% target in the medium-term. This would be undesirable as it may require the BoE to take a more aggressive path of rate hikes later on instead of starting a gradual process soon," Pickering argued.
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