The Bank of England (BoE) is beginning to look like the odd one out among the world’s central banks.
A slowdown in global growth looks set to force a loosening of global monetary policy, led by a more dovish US Federal Reserve which prefers lower interest rates.
Meanwhile, the BoE continues to suggest it is minded to tighten policy rather than loosen it. At the BoE’s last meeting in May, governor Mark Carney suggested UK interest rates may have to go up faster than expected in the event of an orderly Brexit.
Since then, several Bank officials have warned that the monetary policy committee (MPC) is still on track to raise rates several times over the next couple of years.
Last week deputy governor Ben Broadbent told MPs: “Were the economy to develop in line with our projection... interest rates would probably have to rise by a little more than what was in the curve at the time of the forecast” (the ‘curve’ giving an indication of market expectations).
This stands in stark contrast to the US, where the Fed has sounded ever more cautious in recent months, and where investors now expect interest rates to fall three times before the end of the year.
The UK position might sound a little puzzling, given the toll the Brexit drama is having on the UK economy. Despite both US and UK data showing a slowdown in growth, the central banks are not reacting the same way.
The Fed is choosing to look past a tight labour market and focus on the overall economy, which is currently slowing.
The BoE can see a similarly tight labour market here, and an economy under similar pressures, but with an extra dash of Brexit uncertainty on top. But recent comments from MPC members suggest they are staying optimistic about the political situation.
The Bank's rationale
According to BoE forecasts if the worst-case scenario is avoided, the British economy will bounce back sharply.
With unemployment low, that should lead to a rise in wages and, more importantly, a rise in inflation expectations.
But the problem with this analysis is, looking at our usual economic indicators, it is hard to argue that current interest rates are too low.
Investment has taken a serious hit, the housing market looks lethargic, real (that is, inflation-adjusted) wage growth is still lagging and business sentiment is low. Much of this has to do with Brexit uncertainty, but the fact is UK companies, especially car makers, are struggling.
Usually, the key sign that interest rates are too low and thereby causing instabilty is large credit growth. This is particularly true of consumer credit, which pushes demand beyond the economy’s capacity and thus leads to rising prices.
But there is little sign this is happening. Unsecured borrowing, for example, shows little sign of any activity.
Then there is the housing market.
In its residential property survey last week, the Royal Institution of Chartered Surveyors had a mostly downbeat message for UK property.
House prices in the south-east, particularly London, are clearly still under pressure.
But there were some bright spots, including a more supportive commentary on sales than in recent months.
While letting agents are concerned about the ban on tenant fees (perhaps given the impact on their own profit margins) the overall rental market is showing some improvement.
Outside of the south-east things are not as bad, with one estate agent commenting that the market is “still strong due to urban (mainly London/Essex) mass exodus.”
In fact, the Halifax house price index is actually showing a fairly strong reading for the UK overall, with an approximate annualised rate of 12 per cent.
We suspect the BoE’s view of the housing market is one of the main reasons for its hawkishness.
It is probably concerned that a surge of optimism if Brexit uncertainties suddenly disappear could cause house prices to jump, as they did in the 1980s and early 2000s.
That may not seem likely, but when you bear in mind the current ‘mortgage war’ among the banks, it sounds less far-fetched.
But that scenario is wholly dependent on a strong labour market. If employment starts to flake and consumer confidence comes under pressure, house prices will have little support; on that front, things are looking uneasy.
It seems that every day we get more headlines about companies under stress. If that continues, we could see a bout of lay-offs, pushing up unemployment.
Fortunately, the current data has yet to show any signs of this. With austerity policies becoming politically unpopular in all major parties, public spending is likely to increase, or at least stay the same, regardless of what happens in Westminster. That should at least keep public sector employment stable.
The thorn in the side
So what should we make of all of this?
As much as the BoE’s inflation fears may seem odd to some, they are perhaps understandable.
Inflation has been stable for a considerable period of time and public expectations of the long-term trend – which is the Bank’s main concern – are usually fairly stable.
But the housing market has long been a thorn in the side of policymakers, and if they suspect that it will turn quickly, they will want to act. As Mark Carney approaches the end of his term, you can understand why he would be concerned.
As always, the key question is whether that concern becomes a reality.
At the moment, as with so many other things, this seems to depend largely on Brexit. If Brexit has a happy ending before the year is out, expect higher deposit rates and yield.
However, amidst all the uncertainty it is hard to see that happening - and the market seems to agree.