Carney's Talking, but Markets Aren't Listening

(Bloomberg) -- Which is more important, what you read or what you hear?

Bank of England Governor Mark Carney did his best to put a hawkish spin on the U.K. interest rate outlook at the press conference following Thursday’s policy decision. Yet the pound wasn’t buying it. The published data outweighed the rhetoric, and the chances of a rate hike anytime this year have slipped. Not risen. 

The May Inflation Report told the story of an economy that is at best slowing. The bank made some notable forecast downgrades. Most surprising is a shift to an expectation that wages will rise by 2.75 percent this year, down from 3 percent forecast in February.

Assuming three quarter-point rate increases over the forecast period, inflation hits the 2 percent target. That’s hardly the stuff of an urgent tightening cycle.

No wonder the bank had to hold off on raising rates this month. But it doesn’t make the chances of a hike in August any more likely, either. Investor bets on the probability of an increase that month dropped below 50 percent from nearly 60 percent before Carney started speaking. Somebody wasn’t listening. 

And yet, Carney was keen to keep alive the expectation of a hike sometime this year, claiming, among other things, that the bad weather that dragged down first-quarter growth didn’t have to set the tone for the rest of the year (and the bank is expecting the reading to be revised up to 0.3 percent). He was at pains to say that nothing had really changed from February — a time when he was happily talking up rate increases.

I argued earlier this week that Carney’s swings on rate guidance have cost him some credibility, and he was going to struggle to deliver a “hawkish hold” today. That seems to have happened. Investors are putting more weight on the economic numbers than the bank’s vision as expressed by the governor at the press conference. The pound dropped after the event started, and his remarks did not produce a recovery. More to the point, it has stayed lower after falling very hard in recent weeks, not to mention that the 10-year gilt yield is down five basis points from Wednesday.

Steven Major at HSBC had already given up before the BOE published its projections. He cut his forecast for 10-year gilt yields to a phenomenally low 1 percent by the end of the year, a real drop from the current 1.42 percent. It almost goes without saying that he sees no rate increase this year or next. Mizuho forecasts 1.1 percent yields at year end, and Citigroup has turned bullish on gilts versus bunds. The BOE has lost the argument in more than one corner of the city. 

U.K. rate markets will make up their own minds on the prospect of a rate hike this year — whatever guidance the governor gives.

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