It’s all up in the air with central banks

Have the central banks become sources of confusion for investors? We may well think so after comments by the president of the European Central Bank Mario Draghi, and the governor of the Bank of England Mark Carney. At the ECB conference held during the week of June 26, both made comments suggesting a swift change in the two institutions’ policies.

Mario Draghi referred to above trend growth in the euro area to imply that the ECB should factor this in when deciding on its strategy. He stated that “deflationary forces have been replaced by reflationary ones”, and listeners instantly took this as a sign of the end to monetary accommodation with the beginnings of tapering at a specified date. This prompted a surge in the euro against the dollar and a swift rise in long rates. The ECB indicated that this reaction was too forceful and that investors had over-interpreted the president’s comments.

Meanwhile at the Bank of England, Mark Carney hinted at an interest rate rise by the central bank, having displayed quite a different stance just a few days before. At the latest Monetary Policy Committee meeting, the Canadian governor of the Bank of England had left the policy stance unchanged, leading to a rise for sterling and the 10-year interest rate. Continue reading

The Bank of England dilemma

Interesting time in the UK as the Bank of England is facing an important arbitrage. There are potentially two types of shocks in the UK.
One is associated with the consequence of the Brexit on the growth momentum. And the other reflects higher inflation rate (above the 2% target).
The BoE meeting this morning has shown that MPC members may have very different views on monetary policy drivers. At this meeting the vote was 5 for rate stability and 3 for higher rates.
Just a reminder: the BoE has reduced its main rate to 0.25% last July just after the referendum on Brexit in order to accommodate the possible negative risk associated with the referendum result.

Two graphs on recent data can illustrate the MPC dilemma.  Continue reading

Inflation on the upside in the United Kingdom

The current acceleration of the inflation rate creates a complex situation in the United Kingdom as it weighs on households’ purchasing power.
In April the inflation rate was at 2.7% and the core inflation rate was at 2.5%. The inflation rate has not been so high since the fall of 2013 and november 2012 for the core rate. This is mainly the impact of the depreciation of the currency after last june referendum on Brexit.
A year ago the inflation rate was at 0.3% and the core inflation rate was at 1.2%. This latter magnitude is worrisome as the economy is not growing more rapidly.
The main issue is that wages momentum will not follow the inflation profile.  Continue reading

Brutal adjustment on property funds in the UK

The logic behind the brutal adjustment on property funds in the UK is quit simple.
For non resident investors, the deep depreciation of the sterling has led to lower or negative returns. At the same time the UK economic and financial environment appears gloomy and uncertain creating incentives to limit portfolio exposure to assets of this country.
The property market is a market with low liquidity even in normal time. It takes time to sell an asset; that’s a major characteristic of this market. When there are massive flows of redemption this low liquidity vanishes. What is new, is that the environment and expectations are gloomy, therefore nobody wants to invest in this type of asset. It’s even harder on this market as prices are already very high. What could be the return for a new buyer? That’s the important question. Clearly the answer is probably negative and nobody wants to take this type of risks.
Therefore property funds are not able to manage the flow of redemptions. By definition this market has low  liquidity. In the current environment this liquidity has vanished. The mechanism of adjustment is blocked: lots of sellers but no buyers. That’s what we’ve seen in recent days.
There are two options: one is to let the invisible hand in an environment in which the currency will continue to drop (see here). The possibility of a run is not null in that case. It will be the role of the central bank to intervene. The Bank of England is more proactive after the Brexit and it will have to continue.

Central Bankers and Inflation

I have liked central bankers’ discussions on inflation at the Jackson Hole symposium.
The ECB confirms that there will be a bit more inflation and that it justifies the implementation of QE
The Fed and the BoE expect an acceleration of the inflation rate in the future because, when this will be the case, it will justify the contemporary implementation of more restrictive policies.
But in all three cases, inflation is non-existent today.
This gives a very weird vision indicating that central banks still do not really understand inflation trigger mechanism. That is why there is no urgency to intervene. It will probably be more effective to intervene a little too late a little too soon.
Note also that 2% inflation is just the what is considered as neutral for central bankers it is the target for every central bank. An inflation rate of 2% is equivalent to price stability. It doesn’t correspond to an inflation rate that diverge with a high risk to go much higher.
Central bankers do not succeed to find a way to converge to the 2% target. Moreover they give the impression that the situation around the target is asymmetric: not so bad below and combat it urgently beyond. Not sure that the asymmetry is desirable when it is accompanied by limited wage growth which affects the dynamics of domestic demand, major source of growth (see here)