Stronger Pound May Give BOE Hawks Further Pause for Thought
(Bloomberg) -- The resurgence of the pound in recent months may weigh on the Bank of England’s outlook for inflation in its new forecasts, complicating the case for an immediate interest-rate hike.
Sterling earlier this month climbed to the highest level against the dollar since the day after the Brexit vote. Even after slipping last week -- when data showed consumer-price growth at the weakest in a year and Bank of England Governor Mark Carney hinted that a May interest-rate hike was not the nailed-on certainty investors previously thought -- it remains one of the best-performing major currencies in 2018.
Most pertinently for the BOE, its own trade-weighted measure of the pound’s strength has recovered about half of its post-referendum losses.
“If the appreciation in trade-weighted sterling were to be maintained then that’s something which will be felt when it comes to inflation,” said George Buckley, an economist at Nomura in London. “If it’s happened independently of the data, which it looks like it has, then that might mean a lower inflation forecast.”
As the central bank prepares to update its quarterly economic projections for the May 10 Inflation Report and policy decision, the pound’s average level over the past seven days -- which will likely feed into the 15-day mean used to condition those estimates -- stands about 2 percent higher than the assumptions in February. The impact of that may or may not be offset by other factors, such as stronger-than-expected oil prices, in the new forecasts.
Yet just as the currency’s plunge in 2016 fanned faster inflation, its recovery may drag the rate lower. There is already evidence that the impact of pound’s drop has faded, with a report last Wednesday showing inflation slowed to 2.5 percent in March, down from an almost six-year high of 3.1 percent in November.
That could weaken the case for a hike next month. Last week, traders were assigning a more than 80 percent chance of such a move. Carney pulled that down to 50 percent by using a BBC interview to note recent weak economic numbers and said that policy makers are conscious there will be other chances to raise rates this year.
The currency’s move since the last forecast round is likely to knock about 0.1 percentage point off inflation estimates over the next two years, according to calculations by Dan Hanson at Bloomberg Economics. Absent of other changes, that’s potentially enough to bring the measure close to the target in 2020. Add in the softer-than-expected inflation numbers from the first quarter, and the projections could be lowered even further.
The pound was little changed at $1.3930 on Tuesday. Though down from as much as $1.4377 last week, it remains more than 3 percent higher in 2018.
While the BOE has stressed that it would only hike at a “limited and gradual” pace following its first increase in a decade last year, it prompted speculation of a steeper path in February when it said rates needed to rise somewhat earlier and to a somewhat greater extent than previously anticipated.
Michael Saunders was one of two dissenters in favor of an interest-rate increase in March. He said last week that while the effect of the pound’s depreciation is starting to fade from headline inflation, that “may not have much implication either way for the inflation outlook two or three years ahead -- which is the main focus for monetary policy decisions.”
A higher pound would bolster the case made by Andrew Goodwin at Oxford Economics, who questions how quickly officials can normalize policy. The firm’s forecast, based on a move in the pound to $1.47 by year-end, sees inflation dropping below the BOE’s 2 percent target within months, far quicker than the central bank currently forecasts.
The BOE is “worried about the idea that they need to be ready for the next downturn and they need to have some scope to cut rates, so I think ultimately they would like to get rates a bit higher,” said Goodwin. “If we get to the stage where inflation is continuing to sink below target, it’s unlikely to cause them to stop entirely, but it may just slow that pace down.”
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