Carney & Co Retain a Cautious Optimism Before Treasury Select Committee

The Treasury Committee hears from Governor and Chief Economist of the Bank of England, and External Members of the Monetary Policy Committee on its Inflation Report for February.

Mark Carney and MPC members Andy Haldane, Ian McCafferty and Gertjan Vlieghe are testifying.

Carney took some shine off Sterling's performance when he suggested developments in inflation expectataions are important factor in the BoE's tolerance of inflation overshoot but that the overshoot was "entirely due to" a weak Pound.

This suggests he is unconvinced the economy is generating the kind of inflation required to justify a pro-GBP rise in interest rates.

The Bank also thinks higher prices from Sterling's fall and rising oil prices will throttle some consumer spending as incomes get squeezed and they haven’t fundamentally changed view on long-run impact of Brexit.

At the time of the February Inflation Report's release we saw Sterling fall against the Euro, Dollar and other major currencies as the Bank lowered it's inflation projections despite raising growth forecasts.

In the Bank's view the economy can therefore grow further without generating any organic inflation - i.e that inflation that comes from wage rises.

At present inflation is being driven by external factors (oil prices) and the one-off event of a major fall in the Pound.

We have since heard from the Bank's external member Kristin Forbes that in her opinion the Bank should start raising interest rates sooner rather than later to ensure the future path of rate rises are gradual.

This proved positive for Sterling and counterbalances the more dovish-sounding Carney.

In light of this, we find it interesting Ian McCafferty told the Select Committee he believes there is justification for reducing the BoE’s equilibrium on unemployment, but is unsure about the size of reduction.

He would prefer a reduction to 4.75% rather than 4.5%.

“Skills shortages & level of vacancies suggest we are closer to full employment than weak wage growth suggests,” says McCafferty.

Some members of MPC thought equilibrium unemployment rate could be below 4.5%, others on the MPC thought it could be 4.5%-4.75%.

Treasury Select Committee member John Mann suggested that the massive inward inward migration from 2003 means the whole model of labour supply and wage price responses is not reliable as there is no fixed employment pool with employers bringing in “vast amounts” of people.

This suggests the economy may never find an equilibrium employment rate.

The Bank’s Gerthan Vlieghe says looking at the size of the labour pool is almost irrelevant as the increase in people adds to an increase in demand ensuring the model balances.

However, the Governor acknowledged that the Brexit process may yet proceed smoothly, and this would imply a higher path for interest rates.
"There are scenarios where this process proceeds relatively smoothly to an increasingly clear end point and that will be consistent with a higher path for interest rates," said Carney.

Carney however also said there was also a "less optimistic" scenario for the economy, which would dampen the path for rates.

So for every pro-GBP message, there was a GBP-negative counter. This is to be expected from a Bank that has become quite skilled in ensuring it maintains a stable tone.