19 May 2023: Bank of England needs to be careful about forward guidance

The Bank of England must guard against “painting itself into a corner” by providing guidance to the markets about its intentions regarding monetary policy.

That was the conclusion of a conference hosted by the Federal Reserve of Atlanta earlier this week. By providing guidance to the markets in advance the Bank faces the prospect of either being accused of misleading traders and analysts should subsequent data releases mean it has to change its mind or pre-empting the votes of committee members who are entitled to have sufficient time to consider all options before casting their vote.

It becomes far harder to pivot on interest rates when the market has already been appraised of the Bank’s intentions.

Over the past year or so, the intentions of the Monetary Policy Committee were fairly clear, so advance guidance was acceptable, but as rates reach neutral territory or become restrictive on demand, the actions of the MPC become a little less clear.

Maybe having signalled a pause in rate hikes, data on, say, inflation, output or employment may unexpectedly spike, which would leave the Bank open to criticism were it to then hike rates again.

That is why several Central Banks, particularly in the developed world are coining the phrase, data-dependent, to allow them to be nimbler, which allows them to provide as much information as possible without becoming “married to a certain path.

The long-running era of massive house prices is coming to an end as its link to historically low-interest rates also finishes. Householders have become used to seeing their homes as an investment, as opposed to their dwelling. This has been the case since the Thatcher era, when homeownership was positively encouraged.

With population growth also stalling, families are less likely to outgrow a property while potential first-time buyers spend more time living with their parents as it becomes more difficult to save a deposit.

This will be offset, to a certain extent, by mortgage providers who are slowly beginning to reintroduce certain products that were previously considered too risky, including 100% mortgages. Borrowing the full value of a property, or in some cases more than that, became popular when house prices were rising almost daily, and the market was buoyant. That is unlikely to be the case as the economy enters a period of relatively high-interest rates.

Sterling has run into some selling interest this week after three weeks of solid growth. Having reached its highest level in a year against the dollar, it has seen something of a correction, falling to a low of 1.2440 and closing at 1.2449.

Figures for weekly jobless claims were published yesterday and the data showed a sharp fall for initial as well as continuing claims.

Having been gradually creeping higher as the effect of interest rate hikes begins to dampen demand, the data showed that there remain continuing offers of work, although the data shows that to be becoming more regional and less widespread.

The four-week average fell from 245.25k to 244.25k, its first fall in several weeks.

It is not so long ago that a figure of 200k was considered pivotal, but even as the monthly employment data has shown significant resilience, jobless claims have seen growth.

While one dataset is not about to change the minds of the FOMC, employment data, in all its forms, is undoubtedly something that is of considerable influence.

The regional nature of strength, or otherwise, in the economy has been highlighted this week by speeches from the Presidents of Feds from various parts of the country, in which their attitude to the possibility of a further hike in interest rates has varied considerably.

Those attitudes can be overlaid on the economic performance of some states that are seeing more resilience than others.

Later today, the Fed Chairman will speak on the subject of the economy and its reaction to the growth of digital currencies, He is expected to take questions and is certain to be asked if he feels the time has come for a pause in rate hikes, Another certainty is that he will bast the question away, using the “data dependence” argument.

Next week sees the release of the minutes of the latest FOMC meeting. They will show how close the committee came to pausing rate increases.

Also, due for release, is a further update of Q1 GDP, as well as data for durable goods orders.

The dollar index has had a better week so far, rising to a high of 103.62, as traders saw an opportunity in its correction to around the 101.70 level.

Concerns are growing that the hold that the more hawkish members on the Governing Council of the ECB may lead to the choking off of growth in the region entirely.

The attitudes to the seriousness of high inflation vary considerably across the Eurozone and the “uneasy peace” that has existed so far this year is in danger of collapsing as the data for eurozone-wide and regional growth is showing signs of being dampened considerably by continued rate hikes.

The Frugal Five, Austria, Germany, The Netherlands, Belgium and Finland, have solid manufacturing bases that, although suffering due to the continued raising of rates are sufficiently resilient to bounce back when rate hikes come to an end.

Other nations, particularly, the so-called “Club Med” States find that confidence and reliance on tourist income which is seasonal at best is easy to lose, but less easy to recover, as can be seen from the data for “staycations” in the wealthier northern states.

Christine Lagarde remains sold on the idea of further rate hikes, although the idea of two more hikes before the ECB considers a pause is pure fantasy.

There is little doubt that the notion of a pause is being constantly considered at meetings like that of Ecofin which was held earlier this week.

Significant headwinds, in the shape of tighter monetary and fiscal policy, are strengthening, and it may be that the rumours of two further hikes may be too hawkish. There is something of a dichotomy building that sees weak growth and demand, but strong employment figures.

This is being seen across most of the G7 and will undoubtedly be the subject of a study once inflation has been defeated. For now, it remains little more than an anomaly that has to be dealt with along with several other issues.

This week has seen the euro again shy away from the 1.10 level versus the dollar, and there is now significant resistance that is bringing selling interest on any approach to that level.

It has reached a low of 1.0759 so far, but that is still a significant improvement from where it was at the start of the year when a concerted challenge on parity was not only feared but expected.

Have a great day!