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BOE FOCUS-Higher rates loom as BoE's credibility questioned
inspector_monkfish
Posts: 9,276 Forumite
14:33 11Jan11 - BOE FOCUS-Higher rates loom as BoE's credibility questioned
* British inflation highest in G7
* Investors demand premium for future inflation risks
* Markets move to price in two UK rate hikes this year
LONDON, Jan 11 - Concern the Bank of England has lost its grip on inflation has risen to such a level that markets are increasingly pricing in an interest rate rise by the summer to prevent a full-blown credibility crisis.
British inflation has surged to a six-month high of 3.3 percent -- well above that of any other G7 country -- and looks set to hit 4 percent early this year, double the target.
The consumer price inflation measure has exceeded the 2.0 percent target for most of the last three years and the broader retail price inflation measure is even higher at 4.7 percent.
Industry groups fear that louder mutterings about the central bank's credibility could drive it to tighten policy before a fragile economic recovery warrants it, particularly with harsh government spending cuts about to bite.
"If you tell a central bank it has lost credibility, you almost invite it to overreact," said David Kern, chief economist at the British Chambers of Commerce.
Pressure is mounting, however, in financial markets where investors are losing faith in the BoE's assessment that prices are being driven up simply by temporary factors.
Since the start of this year, benchmark gilt yields <GB10YT=RR> have risen even as yields on German and French government bonds <EU10YT=RR> have fallen.
Even more worryingly for the BoE, gilt breakeven rates -- the yield gap between conventional and inflation-protected government bonds -- have soared, reflecting growing fears that the central bank will struggle to bring inflation back down.
Five-year gilt breakeven rates have jumped 50 basis points in little over a month, double the rise in French breakeven rates and far more than the 35 basis point rise seen in the U.S. Treasuries market.
"We're coming to a point where the Bank of England will have to take action to restore its credibility," said Henderson chief economist Simon Ward.
"If it doesn't, it is risking a pick-up in wage settlements, downward pressure on sterling and a loss of credibility that could have a serious cost to the economy."
CREDIBILITY QUESTION
Once lost, credibility for a central bank is hard to recover and some on the BoE's monetary policy committee must surely feel uncomfortable about recent market moves.
Andrew Sentance has so far been a lone committee member calling for higher interest rates but it is possible that one or more of his eight colleagues will join him at the BoE's monthly meeting which ends on Thursday.
Investors are warming to that view that a rate rise by the middle of the year is now a distinct possibility.
Economists are playing catch-up. A Reuters poll early last week found a median still forecasting no rate rise until the last quarter of the year [BOE/INT] but the picture is changing rapidly.
Citi changed its rate call on Friday to predict two rate rises from the BoE this year.
BNP Paribas, which had forecast no tightening this year, now expects a third quarter rate rise, and maybe an even earlier move, while Societe Generale analysts have brought forward their expectation of a first rate hike to August.
"The challenge now is to ensure that the inflation upturn does not develop into a crisis of surging inflation expectations," said Michael Saunders, UK economist at Citi.
The shift in market expectations has been even more dramatic.
Last October, investors believed rates would stay at 0.5 throughout 2011 and the debate was about whether further stimulus was needed. Now, money market rates are pricing a rate rise to 0.75 percent by July and 1 percent by the end of the year.
FORECASTING FAILURE?
Inflation has been above the BoE's 2 percent target more than 75 percent of the time for the last three years and the central bank's line about one-off shocks is starting to ring hollow.
Serious questions are being asked about the central bank's forecasting process, particularly its reliance on estimates of the output gap -- a measure of slack in the economy which can be taken up without generating inflation -- and its belief that slow broad money growth precludes sustained price pressures.
Although rising commodity prices have led to a resurgence of price pressures across much of the world, the credibility issue for the Bank of England is particularly acute.
In the euro zone inflation has only just broken through the European Central Bank's 2 percent comfort ceiling while in the United States it is running at little over 1 percent.
Henderson's Ward, who has been an outspoken critic of the BoE's forecasting methods, says the central bank is over-estimating both the extent of the output gap and its disinflationary impact.
"Increasing globalisation means the sensitivity of inflation to the domestic output gap has fallen considerably since the last recession of the 1990s," said Ward. "It would make more sense for the BoE to be focusing on the output gap of the global economy."
The BoE's poor track record has even raised suspicions that it is deliberately turning a blind eye to inflation to give a tailwind to the recovery, a charge it has vehemently denied. But it may need to take action quickly to prevent a loss of credibility turning into an unfortunate legacy of mistrust. (Editing by Mike Peacock)
* British inflation highest in G7
* Investors demand premium for future inflation risks
* Markets move to price in two UK rate hikes this year
LONDON, Jan 11 - Concern the Bank of England has lost its grip on inflation has risen to such a level that markets are increasingly pricing in an interest rate rise by the summer to prevent a full-blown credibility crisis.
British inflation has surged to a six-month high of 3.3 percent -- well above that of any other G7 country -- and looks set to hit 4 percent early this year, double the target.
The consumer price inflation measure has exceeded the 2.0 percent target for most of the last three years and the broader retail price inflation measure is even higher at 4.7 percent.
Industry groups fear that louder mutterings about the central bank's credibility could drive it to tighten policy before a fragile economic recovery warrants it, particularly with harsh government spending cuts about to bite.
"If you tell a central bank it has lost credibility, you almost invite it to overreact," said David Kern, chief economist at the British Chambers of Commerce.
Pressure is mounting, however, in financial markets where investors are losing faith in the BoE's assessment that prices are being driven up simply by temporary factors.
Since the start of this year, benchmark gilt yields <GB10YT=RR> have risen even as yields on German and French government bonds <EU10YT=RR> have fallen.
Even more worryingly for the BoE, gilt breakeven rates -- the yield gap between conventional and inflation-protected government bonds -- have soared, reflecting growing fears that the central bank will struggle to bring inflation back down.
Five-year gilt breakeven rates have jumped 50 basis points in little over a month, double the rise in French breakeven rates and far more than the 35 basis point rise seen in the U.S. Treasuries market.
"We're coming to a point where the Bank of England will have to take action to restore its credibility," said Henderson chief economist Simon Ward.
"If it doesn't, it is risking a pick-up in wage settlements, downward pressure on sterling and a loss of credibility that could have a serious cost to the economy."
CREDIBILITY QUESTION
Once lost, credibility for a central bank is hard to recover and some on the BoE's monetary policy committee must surely feel uncomfortable about recent market moves.
Andrew Sentance has so far been a lone committee member calling for higher interest rates but it is possible that one or more of his eight colleagues will join him at the BoE's monthly meeting which ends on Thursday.
Investors are warming to that view that a rate rise by the middle of the year is now a distinct possibility.
Economists are playing catch-up. A Reuters poll early last week found a median still forecasting no rate rise until the last quarter of the year [BOE/INT] but the picture is changing rapidly.
Citi changed its rate call on Friday to predict two rate rises from the BoE this year.
BNP Paribas, which had forecast no tightening this year, now expects a third quarter rate rise, and maybe an even earlier move, while Societe Generale analysts have brought forward their expectation of a first rate hike to August.
"The challenge now is to ensure that the inflation upturn does not develop into a crisis of surging inflation expectations," said Michael Saunders, UK economist at Citi.
The shift in market expectations has been even more dramatic.
Last October, investors believed rates would stay at 0.5 throughout 2011 and the debate was about whether further stimulus was needed. Now, money market rates are pricing a rate rise to 0.75 percent by July and 1 percent by the end of the year.
FORECASTING FAILURE?
Inflation has been above the BoE's 2 percent target more than 75 percent of the time for the last three years and the central bank's line about one-off shocks is starting to ring hollow.
Serious questions are being asked about the central bank's forecasting process, particularly its reliance on estimates of the output gap -- a measure of slack in the economy which can be taken up without generating inflation -- and its belief that slow broad money growth precludes sustained price pressures.
Although rising commodity prices have led to a resurgence of price pressures across much of the world, the credibility issue for the Bank of England is particularly acute.
In the euro zone inflation has only just broken through the European Central Bank's 2 percent comfort ceiling while in the United States it is running at little over 1 percent.
Henderson's Ward, who has been an outspoken critic of the BoE's forecasting methods, says the central bank is over-estimating both the extent of the output gap and its disinflationary impact.
"Increasing globalisation means the sensitivity of inflation to the domestic output gap has fallen considerably since the last recession of the 1990s," said Ward. "It would make more sense for the BoE to be focusing on the output gap of the global economy."
The BoE's poor track record has even raised suspicions that it is deliberately turning a blind eye to inflation to give a tailwind to the recovery, a charge it has vehemently denied. But it may need to take action quickly to prevent a loss of credibility turning into an unfortunate legacy of mistrust. (Editing by Mike Peacock)
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Comments
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Allow me to be the first....
Timberrrrrr!:DIt's getting harder & harder to keep the government in the manner to which they have become accustomed.0 -
Markets expect 1% by the end of the year.
My mortgage could go up to nearly £200.:eek:
Up to £60 less going in my offset?
If they carry on at that pace it will be 5% by 2019.
0 -
In the euro zone inflation has only just broken through the European Central Bank's 2 percent comfort ceiling while in the United States it is running at little over 1 percent
Which begs the question, what is so different in those economies ?'In nature, there are neither rewards nor punishments - there are Consequences.'0 -
I wonder what effect the drop off of the vat rise will have Q1 2012?
VAT must be adding 2%ish to the figures, I imagine the BOE are going to have a pretty big helping hand after it happens.
I can see one, possibly 2 25bp rises this year, taking us up to 1%. If people are thinking rises will take us back to 5% over the next 2 years, IMHO, they are mistaken.
I do agree though, that any rise is going to push a lot of people into trouble. could get interesting, as minor drops in prices could turn into a full rout if supply increases significantly. There is no support at current price levels, especially if we start to see lots of forced sellers.0 -
how does increasing rates counteract the rise in inflation due to VAT?I wonder what effect the drop off of the vat rise will have Q1 2012?
VAT must be adding 2%ish to the figures, I imagine the BOE are going to have a pretty big helping hand after it happens.
I can see one, possibly 2 25bp rises this year, taking us up to 1%. If people are thinking rises will take us back to 5% over the next 2 years, IMHO, they are mistaken.
I do agree though, that any rise is going to push a lot of people into trouble. could get interesting, as minor drops in prices could turn into a full rout if supply increases significantly. There is no support at current price levels, especially if we start to see lots of forced sellers.0 -
It doesnt. But its starting to get very political, you may have noticed in recent weeks.
The BOEs job is just as much about perception than anything else, and forgive my bluntness, but the majority of the population are somewhat lacking between the ears. The BOEs credibility is at stake and nothing more than feeding expectations of a rate rise will correct that. A couple of rate rises later in the year followed by falling inflation in the new year due to the vat drop would work wonders for public confidence in the system and quash wage demands.0 -
increasing rates will have little effect on the reasons that we have inflation or will have inflation.It doesnt. But its starting to get very political, you may have noticed in recent weeks.
The BOEs job is just as much about perception than anything else, and forgive my bluntness, but the majority of the population are somewhat lacking between the ears. The BOEs credibility is at stake and nothing more than feeding expectations of a rate rise will correct that. A couple of rate rises later in the year followed by falling inflation in the new year due to the vat drop would work wonders for public confidence in the system and quash wage demands.
it's quite simple those people that think that increasing rates will combat inflation directly don't actually understand.0 -
I can see BoE putting in a couple of small increases over the year, just to show that they are doing something. They are losing credibility by just sitting on their hands whilst inflation increases. It may not have a direct effect on inflation, but the charge of just sitting back and letting it happen does them no favours politically.0
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increasing rates will have little effect on the reasons that we have inflation or will have inflation.
it's quite simple those people that think that increasing rates will combat inflation directly don't actually understand.
Look, I fully agree, but daily mail readers wont understand that. Perception is everything.0
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