Central banks keep the markets on their toes

A famous quote attributed to the great British economist John Maynard Keynes goes, "when the facts change, I change my mind". It would seem that Bank of England governor Mark Carney takes a similar view.

The Bank of England has spent much of the past year dampening down market speculation about possible rises in UK rates, notably through its forward guidance policy proclaiming that rates could remain low.

However, in a speech last Thursday, Carney caught markets off guard by warning that UK rates could rise sooner than expected, given recent strong economic data. His comments gave sterling a significant boost but weighed heavily on the gilt market and UK stocks.

It may be that Carney is forewarning the markets about some surprising news in the minutes of the June meeting of the monetary policy committee, due to be published tomorrow. The May minutes signalled some concerns, stating that “for some members the monetary policy decision was becoming more balanced”.

There were differing views, too, on the committee with regard to the level of spare capacity in the economy, a key factor in determining when rates will need to rise.

Overall, the markets took the May minutes to mean that some committee members might start to vote for rate hikes in the second half of 2014, but policy would still not be tightened until next year.

The June minutes may well show that some committee members actually voted for a rate hike this month, while also hinting that rate tightening was likely later this year.

The latest data on the economy has been particularly strong, suggesting that growth may be accelerating from the 3% rate evident over the past year. Retail sales rose by 1.3% in April for a year-on-year gain of 6.9%, the strongest growth in a decade.

Manufacturing output rose by 2% in the three months to April. The unemployment rate is continuing to fall rapidly, averaging 6.6% in the three months to April. Employment rose by 2.6% year-on-year in the same period.

Leading indicators on the UK economy, such as PMI surveys, have also been very upbeat recently, suggesting that activity will remain strong in the months ahead.

Meanwhile, many commentators, including Bank of England officials, have warned that the UK needs to ensure that its property market does not overheat. The latest data from Halifax show that prices jumped 3.9% in May.

In this regard, there will be plenty of interest in today’s meeting of the Bank of England financial policy committee, which is due to discuss housing and other stability risks.

The markets will be interested to see what, if any, recommendations it makes in terms of tightening lending criteria. It may well be that the bank feels some rise in interest rates may also be required to cool the housing market.

As in the UK, a key focus for US markets is central bank policy. The Federal Reserve meets this week, and will also publish its latest economic projections.

A further $10bn (€7.4bn) reduction in asset purchases is expected to be announced by the Fed as it continues to gradually scale back its quantitative-easing programme.

The markets will be on the lookout for any hints on the timing of interest rate increases, given the more hawkish soundings from some Fed officials recently and the continuing marked fall in the unemployment rate.

Overall, though, unlike the Bank of England, the Fed is likely to stick to the script that any rate hikes are still some way off, given that it is still in the process of winding down its quantitative-easing programme.

- Oliver Mangan is chief economist with AIB