September 10, 2015

The Bank of England (BoE) stayed put today which was no surprise. And neither were September’s MPC minutes showing no change to voting and including much talk about China, Emerging Markets, financial market volatility and the impact of depressed commodity prices on already ‘missing in action’ inflation. Nothing major so far – downside risks have increased. However, given that the BoE is closest to the US Fed in terms of pulling the trigger on policy reversal from historically accommodative stances, today’s update likely provides an inkling as to how the Fed FOMC will vote next week. Markets remain extremely uncertain, although we’re not sure why. The Fed is unlikely to do anything except explain why it prefers to wait that little bit longer.

Both the US and UK are in pretty good shape post crisis, with growth back to something akin to robust and unemployment down sharply from crisis highs. The missing piece for both, however, remains inflation which represents one half of both central banks’ dual mandates (of course both see this returning to 2% target, but that debate is for another time). However, if the BoE is so worried about the above, can we not assume that the same Fed meeting next week will involve the same concern over the same external factors. So surely Janet et al. are more likely to stick rather than twist.

Marc Faber has said the Fed’s next move could be QE4 and Larry Summers said that if it hikes it may have to reverse the call shortly after. Janet Yellen will definitely not want to end up with egg on her face. There’s too much at stake. After 7 years of crisis, the Fed shoulders a huge responsibility in terms of symbolising crisis end and taking global monetary policy on its first steps back towards normality (a ‘new normal’ – low rates for a good while, unlikely to see long term averages for many years). Yellen has already worked hard to put us at ease, promising that hikes will only be slow and gradual and only when the time is right. However, markets remain petrified.

A rate hike in itself is unlikely to stop the world turning but markets view the threat as signalling the beginning of the end of cheap money rather than exit from crisis. That’s just how markets think after so many years of being spoilt with low rates and easy money boosting risk appetite while major central banks repeatedly show willingness to step in to avoid disaster when required. The recent summer rout shows how markets remain fragile. If the US is not quite ready and the planned hike is more symbolic than anything, aiming to show that policy can’t stay this loose forever, then what’s the harm in waiting for things to calm down a bit first? How about an early Christmas present Janet?

Mike van Dulken, Head of Research