- Economists accuse BoE of confused reading of economic data
- But, others argue the Bank is in fact being consistent on its key message
- Defence of the Pound a major part of current policy direction
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The Bank of England's desire to continue raising rates has baffled some economists who say it is picking and choosing data to suit a preset agenda.
The British Pound strengthened on June 21 after after the Bank of England communicated the results of most recent policy meeting; the reaction by the currency confirms the message surprised markets by signalling interest rates might rise as soon as August.
Three key indicators hinted at this 'hawkish' outcome: 1) Chief Economist Andy Haldane decided to join Ian McCafferty and Michael Saunders in voting in favor of a rate increase.
2) The Bank will look to start reducing its holding of bonds acquired in the quantitative easing programme when the basic interest rate at the Bank hits 1.5%, whereas before the target was 2%
And 3) the Bank is looking through recent soft data and noting signs that economic growth is picking up.
This last point has stumped a number of economists who have expressed concern that the Bank is starting to pick and choose data simply to justify a preordained policy path, a policy path many suggest is wrong considering the lacklustre growth rates seen in the economy of late.
"The case for a hike feels forced, and not justified by a wide array of data. CPI has been slowing over the past six months, initially more rapidly than the MPC expected, and the ONS has so far said nothing to support the BoE's contention that Q1 GDP was understated and significantly distorted by bad weather," says John Wraith Strategist at UBS.
Wraith also points out headline average earnings growth has slowed for the past two months, while business investment has been running at just 2% y/y since the referendum, less than half the pace it averaged in the previous six years.
"Not for the first time in recent months, we view the MPC's assessment as being excessively optimistic and would view any further tightening of monetary conditions as unjustified," adds Wraith.
Also trying to make sense of the minutes is Robert Wood, UK Economist at Bank of America Merrill Lynch who says, "the minutes were full of statements we find hard to make sense of."
Wood cites the issue of services inflation as being one area where the Bank is being contradictory in their reading of the economy: "the BoE argued the 50bp drop from January to 2.3%, which was 100bp below the historical average, did not signal disinflationary pressure because it included a boost from sterling's depreciation. But surely if sterling is boosting services inflation wouldn't that mean underlying "domestically generated inflation" was even weaker?"
"We find it hard to make sense of this argument," says Wood. "You can't have it both ways."
Another issue picked up by Wood is the issue of Industrial Production (IP) and stock building where the BoE argues both that 1Q GDP was a blip because consumption has bounced back and April IP weakness was a blip because it was just an unwind of involuntary stock building in 1Q on weak retail sales.
"If the weather lowered retail sales in 1Q but not IP (hence explaining the stock build up) then the weather would have had no effect on GDP as a whole since GDP is the sum of output - IP plus services plus construction. In any case, if retail sales are now rebounding from the weather, as the BoE contends, then why do manufacturers have to cut output to cut stocks when they could just keep output unchanged and let stronger demand eat up stocks?" asks Wood.
The analyst says the Bank can be accused of favouring one volatile indicator over another.
"The BoE seems to discount some data as too volatile to put weight on (construction) but is happy to bases its central argument on terrible indicators (surveys of stock building) of one of the worst measured components of expenditure. If you think construction is too volatile and prone to revision, then it should discourage you from placing any weight on stock building," says Wood.
All of these factors suggest to Bank of America Merrill Lynch a willingness at the BoE to selectively use different aspects of the data to support their central narrative and underlying hawkishness.
What the Bank of England is Actually Doing: Defending the Pound and Staying Ahead of the Curve
So why would the Bank risk being accused of being selective in its approach to data in order to defend an underlying hawkishness?
There is an inherent danger in a central bank being too cautious when it comes to raising interest rates, particulary when an economy is growing, which the UK economy is clearly doing and has been doing for years now.
There could be a point where inflation suddenly surges and the Bank is forced into a series of panicked interest rate rises.
This kind of response is incredibly destabilising for any economy, and a path of gradual and well signposted interest rate rises is always a preferred methodology to adopt, something the Bank has clearly recognised and has consistently signalled over recent months.
Logic dictates that an economy in a mature phase of expansion should not have interest rate settings that are stuck at emergency levels. The Bank of England knows it needs ammunition to draw on if the economy enters another downturn, which is inevitable as economies grow and contract in cycles.
The message the Bank wants to deliver is that we are in a gradual regime of rising interest rates, even if the data is a little erratic.
"The message is clear: the BoE is not shifting off a normalisation path so don't get too bearish on the GBP," says Stephen Gallo, a strategist with BMO Capital.
Another argument for the 'hawkish' tilt being adopted by the Bank is there is a real need to defend the value of the British Pound - and the tone struck this week does just that.
"This set of minutes looks quite doctored up to me in order to shore up Sterling and provide a bit of support to rates," says Gallo.
Former MPC member and senior economic advisor at PwC Andrew Sentance says the Pound is an important economic variable for the economy, and the Bank has an interest in defending its value, a particularly pertinent argument considering the heavy losses suffered by GBP/USD over recent weeks.
“Growth has been relatively weak, but unemployment is historically very low and inflation looks like it will be stuck around 2.5 per cent over the summer. The MPC’s reluctance to raise rates looks like making things worse through its negative impact on the value of the Pound,” says Sentance.
With inflation clearly stuck above the 2% mark, and threatening to go higher over coming months in response to rising global fuel prices, the Bank will be nervous of any further decline in the value of Sterling which would in turn push up the cost of imports.
"From a cost perspective the minutes confirmed that the strengthening in global energy prices implied a firmer CPI profile over the next six months, a trend which would be reinforced if Sterling’s recent weakness were to persist," says Philip Shaw with Investec in London.
Therefore what at first appears to be an inconsistency in its interpretation of the data, actually serves to reinforce a key consistency: That the Bank is going to continue raising rates at a gradual pace.