Hermes Fund Managers group chief economist, Neil Williams, has warned that financial markets are increasingly sensitive to any deviations from the forward guidance given by the US and UK central banks, following long periods of abnormally loose monetary policy.
In the UK, the forward guidance policies of the Bank of England are now so vague as to stretch credibility, Williams said. “Unlike the Fed, the BoE has moved not just the goalposts (by pushing back its unemployment thresholds), but also the rules (by devaluing unemployment as a key policy driver). It now monitors 18 different indicators to guide us toward that first rate rise,” he commented. Williams added that by slowly unwinding QE, the Bank of England could cap the peak interest rate at around 3%.
Williams said that he expected policy normalisation in both the US and the UK to start in 2015 with 25 basis point rate hikes. He added: “Thereafter, to preserve growth, the Fed and BoE will try to minimise ‘peak’ interest rates by first allowing their QE-bought bonds to ‘roll-off’ (ie to mature without reinvestment), before eventually having to sell some of them back to the market via quantitative tightening (QT). However, even this will be a gradual process.” He went on to say that the difficulty the BoE will have is presentation. “While they now look explicitly at a range of capacity indicators, including business surveys, labour participation rates and average earnings, they will have most difficulty explaining the “output gap”. As recovery builds, markets may fear the MPC is subordinating inflation control to growth considerations, especially nearer next year’s election,” Williams commented.