Week In FX Europe – BoE To Judge Slack Before Hike

The Bank of England rate announcement nearly got lost in the shuffle this week. Yesterday, Governor Carney and his fellow policy makers left both the benchmark rate at +0.5% and the overall size of its bond portfolio at £375b.

With the Fed trying to wind down its bond-buying stimulus, the ECB humming and hawing about implementing QE, Governor Carney at the BoE is expected to keep policy unchanged throughout the remainder of this year.

The UK economy is currently “basking in a spell of rapid growth and low inflation.” Earlier this week the IMF indicated that it expects the UK economy to expand +2.9% this year (less than the BoE’s forecasted rate of +3.4%), outpacing both Germany and US growth. Despite the dip in February’s inflation rate (+1.7% annualized), it is expected to hover close to the BoE’s +2% target throughout the year.

Governor Carney has been rather vocal and adamant that UK rates will remain low, keeping the BoE’s easy-monetary policy intact at least until employment improves further and when the nation’s economy is running to its full potential.

Like any G7 monetary authority, the timing of the first rate hike will be of the utmost importance. If authorities wait too long to tighten, inflation may take off. If they act too quickly, then economic recovery could quickly stall.

Fixed income traders are pricing in the BoE’s first-rate hike during Q1, 2015 – perhaps even six-months before the Fed and certainly much sooner than the ECB. No matter when authorities do decide to tighten, any rate rise is expected to be slow and limited to start.

A change in the BoE’s interest rate guidance last month (originally rates were to begin to tighten when unemployment hit +7%, currently hovering at +7.2%) emphasized that once the +7% has been passed authorities would keep a loose monetary policy at least until the “slack” in the labor market and broader economy has been reduced. To date, UK policy makers seem to have underestimated the “real” strength of the own country’s job market.

Expect going forward a hot debate in reference to the word “slack” – Carney thinks there is more “slack” in the labor market than the MPC’s best estimate.

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