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By HaleStewart January 23, 2014 8:34 am
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Bank of England's Meeting Minutes Indicate BOE Is In No Hurry to Raise Rates

Yesterday we had two major releases related to the UK economy: the most recent meeting minutes from the central bank and a big drop in the unemployment rate from 7.4% to 7.1%.  The currency markets reacted with a big Pound rally, sending the Sterling up against the dollar and challenging recent highs.  The currency markets are treating this combination of news as pound positive.  However, a closer look at the fundamentals underlining this trade – and the released data -- should give them pause.

First, let’s place the charts movements into a longer perspective.  The pound rallied relative to the dollar in the second half of last year as the UK economy printed solid economic news while the US appeared to be weakening.  However, at the end of last year, the news from the US – especially the numbers from the manufacturing sector – strengthened.  And, at the end of last year, the Fed announced it would start the tapering process for its asset purchase program.  The sum total of the US news in the fourth quarter was dollar positive, thereby halting the pound’s advance.

Over the last few weeks, we’ve had a return to the news landscape of 4Q13, where the UK news was more bullish than the US.  But while yesterady’s employment news is undoubtedly bullish, a careful read of the BOE’s meeting minutes does not lead to the conclusion that the bank is closer to tightening.  First, consider this analysis of the overall UK economic situation:

The recent strength of both the business surveys and employment growth pointed to above-trend growth around the turn of the year. But the precise pace of growth was uncertain and there were upside risks to the Bank staff’s estimates of growth of a little under 1% per quarter in the fourth quarter of 2013 and the first quarter of 2014. Even so,  make a more significant positive contribution to growth as long as activity in the United Kingdom’s main trading partners remained subduedthe legacy of the financial crisis at home and abroad meant that the domestic recovery continued to face a number of headwinds and its continuation was likely to require a pickup in real income growth, underpinned by a more sustained expansion in corporate spending and an improvement in productivity performance. Net trade had reduced growth in Q3. And while the risks to the global outlook appeared more balanced, it would be difficult for net trade to

The bank is acknowledging the recent stronger growth numbers.  But there is also a clear admission that, because the UK economy is recovering from a credit default economic scenario, potential headwinds are still very strong.  This means the bank is far less likely to raise rates anytime soon.

In addition, there is little inflationary pressure in the system to goad the bank into acting. 

The fall in CPI inflation to 2.0% in December, after more than four years above the target, was welcome, and had been accompanied by downside news about the near-term prospects for inflation. Sterling had appreciated a little further and was almost 3% higher than at the time of the November Inflation Report. Global inflationary pressures were weak and commodity prices had remained subdued. With continued slack in the labour market and low productivity growth, nominal pay growth had remained weak. In addition, Bank staff had revised down their estimate of the likely contribution of administered and regulated prices to CPI inflation over the next two years, reflecting smaller contributions from utility prices and university tuition fees. Against that, the strong growth in employment was consistent with the degree of effective slack remaining within the economy being somewhat less than previously thought. Overall, the news on the month had reduced the likelihood of CPI inflation being above 2.5% at the 18 to 24-month period relevant to the MPC’s ‘knockout’.

The meeting minutes for the latest BOE meeting pour cold water on the notion the bank will start to raise interest rates sooner than anticipated.  In fact, one could make the argument the bank is signaling they’ll raise rates a bit later than anticipated because inflation is low and the economy is still recovering from a several recession.  Any trade based on more immediate central bank action is faulty.

Hale Stewart is a former bond broker who has been writing about economics and financial markets since 2006 on the Bonddad Blog.  He is also a tax attorney with a domestic and international practice while also forming and managing captive insurance companies for US companies.   You can follow him on twitter at:@captivelawyer




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