The controversial decision to raise interest rates at a time of significant economic uncertainty unsurprisingly left Mark Carney on the defensive throughout his press conference on Thursday, as reporters repeatedly questioned why the central bank decided it was the appropriate time for the first rate hike in a decade.
Naturally the decision on whether the raise interest rates is far from straightforward with inflation significantly overshooting the central bank’s 2% target and the labour market in good shape, while at the same time the economic outlook is uncertain at best and real incomes are already being squeezed. While the MPC has been divided on the correct course of action in recent months, the pendulum eventually swung in favour of the hawks with some policy makers clearly of the belief that they had reached the limitations of how much inflation they could stomach.
As can be interpreted from the market reaction though, the rate hike came with quite a dovish twist. Policy makers refrained from including language in the statement that suggest markets were behind the curve on rate hikes which would indicate that two over the next three years is expected, which would represent an extremely gradual tightening process. Given the assumptions that the central bank has on labour market slack and the relationship with wages and inflation, it’s possible that even two hikes may be a little punchy. The experience of the Fed would certainly support this view.
All things considered, the view appears to be that the BoE has taken a risky and unnecessarily step in raising interest rates today, one they may regret and be forced to reverse over the next year or so. Even if this is avoided, with the rate now back at the level the central bank deemed the lower bound for seven years prior to the Brexit referendum, we may be waiting some time for interest rates to rise again.
The BoE’s job may be done for the day but the fun may be just beginning for markets, with details of Trump’s tax reforms and the new Fed Chair announcement still to come. Jerome Powell is expected to be announced as Janet Yellen’s successor late on in the session which will leave another seat available on the Board of Governors for Trump to fill. Certain candidates may have missed out on the position of Chair but with other important roles to be filled, there’s potential for them to join Powell at the top.
Tax reform and the future leadership of the Fed have both been very important factors in the dollar revival over the last couple of months so it will be interesting to see how the greenback responds to both of these events today.
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