“If I seem unduly clear to you, you must have misunderstood what I said.”

25th July 2014

Ian Copelin, Investment Director, my wealth comments “Shortly after becoming the Chairman of the US Federal Reserve in 1987, Alan Greenspan once joked with reporters, “Since I’ve become a central banker, I’ve learnt to mumble with great incoherence.  If I seem unduly clear to you, you must have misunderstood what I said”.

It would appear that Mark Carney, the Governor of the Bank of England (BoE), is of the same school of thought!

After becoming Governor in July 2013, he immediately unveiled ‘forward guidance’, which linked UK interest rates to unemployment and signalled that interest rates would not go up until 2016.  Six months later, with unemployment falling quicker than expected he changed his focus to spare capacity within the economy.  In May the BoE said the UK was still facing headwinds and that there was more spare capacity in the economy that needed to be used up before interest rates needed to rise.  At the same time the BoE said that inflation would probably stay close to its 2% target over the next 3 years based on their expectations for an interest rate increase in the second quarter of 2015.

Then in June, just 4 weeks after entrenching market expectations that interest rates wouldn’t change in the next 12 months, during the Governor’s annual Mansion House speech, Mark Carney warned that interest rates could rise sooner than expected and hinted the first rise could come in 2014.

Less than two weeks later, during comments to a parliamentary panel, Mark Carney again threw the market into confusion when he tamed his statement, stating that he meant “expectations for an interest rate increase for the latter half of the year were relatively low”.  If the market was putting a very low probability on an increase this year, it was because they were simply taking direction from Mark Carney himself!

The problem that Mark Carney has now created is one of uncertainty of when interest rates will rise – and that goes against everything that he and the BoE’s forward guidance has been trying to achieve.

However, if one looks at the data, there is no reason to expect an interest rate rise this year:  inflation (CPI) has been at or below the BoE’s 2% target for over 6 months (one of its longest ever stretch) and has the potential to go lower given the strong pound (Sterling has been one of the strongest developed-nation currencies over the past year) and the supermarket price-war (the main players are investing about £1bn this year in lower prices – the only concern is that only true supermarket price cuts are captured in the inflation data, while special offers such as 3-for-2; buy-one-get-one-free; and vouchers with money off your next shop are excluded).

In addition, producer price inflation (PPI) is currently negative (helped by the stronger pound) and wage pressures appear non-existent (excluding bonuses it is running at less than 1% – in the 5 years before the financial crisis wage growth averaged over 4%).

Although house price inflation (especially in London) is an issue, it is being addressed by limiting riskier mortgages and by the introduction of a new affordability test.  In fact mortgage approvals and new buyer enquiries are already turning down (and as one would expect these measures have previously been good indicators for house prices).

However, it appears that the market isn’t looking at economic data, it is simply fixated on every comment from Mark Carney.

Despite flip-flopping around, I believe that Mark Carney is acutely aware that if he increases interest rates prematurely it could cut off the economic recovery before it has had a chance to really get going and result in considerable costs in terms of lost output.  Consequently, it is my opinion that he will err on the side of caution to ensure nothing derails the economic recovery, especially as inflation and wage growth isn’t a problem.

Yes interest rates will rise, like it or not, but I still don’t believe that there will be an increase in 2014.  And when they do rise I would expect it to be a slow and gradual process and I do not expect that they will return to historical levels, instead peaking at perhaps 2.5% or 3%.”