The three phases of Pound Sterling’s initial response to Carney’s guidance

Judging by market impact alone, Mark Carney’s first public speech since his accession to the governorship was perhaps a disappointment.

In his defence, the market had already heavily anticipated dovish remarks and some key MP members have been assisting with ‘the message’ in the last two weeks.

As such, it was very hard to deliver more: aside from some intra-speech volatility, sterling, forward swap rates and other metrics of BoE expectations ended the day broadly unchanged.

Nonetheless, it is a work in progress and the BoE should take some execution guidance from the Fed.

When gauging the success of its communication, it’s often as much about how the market reacts as the extent of the reaction itself.

We noted right after the BoE’s inflation press conference that there were three phases of sterling’s initial response to Carney’s guidance.

In each phase the driver was distinct and ultimately the perception of a credibility deficit essentially left the market at the status quo.

Thursday’s result was similar, and this is what should be troubling the MPC if they believe the currency is a key input to monetary policy: when the macro indicators which determine policy expectations fail to anchor the currency, then the policy itself is in question.

Of course, there are other drivers out there such as safe-haven flow, from which sterling does tend to benefit during times of geopolitical stress.

Nonetheless, the currency does not respond favourably to growth expectations (via higher yields), and is completely neutral to inflation expectations (measured by the 5-year breakeven).

Given the MPC’s past record with their inflation target, markets can be forgiven for apathy, but this is not the intention of current guidance, especially with inflation-knockouts featuring so prominently in its operation – unless the market views this factor as irrelevant too.

Contrast this to the dollar, which arguably has even more external non-policy drivers than sterling. The currency’s correlation to growth (benchmark yields) and inflation expectations have followed each other well until this year.

The divergence resulted in a very close link between the dollar and breakevens, while Treasury yields lost relevance.

The Fed has been very clear throughout the last few meeting cycles that disinflationary headwinds persist, and was just as, if not more of a potential drag on policy normalisation as the labour market – which seems to be improving ahead of schedule.

Slower growth overseas is only exacerbating the process as the US faces price-push disinflation.

As such, the dollar is tracking the main indicator that affects guidance, thereby increasing policy efficacy. This link will not hold indefinitely, but while it does, policy setting need not second-guess markets. The BoE still has its work cut out on this front.