Minutes from the BoE’s Monetary Policy Committee released yesterday flew under the radar as the focus was naturally on the Chancellor’s pre-election Budget. Still, there were a few interesting points worth singling out:
1. UK equity prices outperforming
Risky asset prices have seen an increase across advanced economies and investment-grade corporate bond spreads have fallen. But according to the BoE this is particularly pronounced in the equity prices of UK firms who service the domestic market. These have outperformed both the UK aggregate index and similarly domestic focused firms in the US. Hooray for UK plc!
2. Spending or saving?
The BoE cites some uncertainty to the impact of lower energy prices on consumer spending. While conventional wisdom is that lower energy prices will boost consumer spending there is a notable caveat; it depends on whether households view the fall in energy prices as permanent or temporary.
If households view the drop in prices permanent then they are more inclined to spend. However, if they view the price change as temporary they are likely to react by saving a large proportion of the additional real income. The latter sounds particularly plausible given recent experiences with global oil prices as well as uncertainty surrounding wage increases.
3. Exchange rate a worry
The sterling effective exchange rate index has reached a 6-year record high this month appreciating by around 2.5%. This mainly reflects gains against the euro (around 4%) but also a slight appreciation against the dollar.
The worry is that a strengthening exchange rate will lead to further entrenchment of low inflation expectations. There are no signs that the sterling will lose value as stronger prospects of growth in the UK compare to the Eurozone as well as divergent monetary policy paths (towards tightening in the UK opposed to loosening in Europe) should continue to place upward pressures on the exchange rate.
4. Risks to inflation target
According to the BoE, sterling appreciation since the February Inflation Report has been offset by the increase of about 25% in the sterling Brent oil spot prices – leaving the impact of inflation neutral in the short-term. However, in the medium-term the effect should leave inflation a little lower on aggregate.
As the majority of the slump in inflation is accounted by temporary factors, mainly weak energy and food prices as well as the sterling appreciation, the longer term outlook for inflation and the probability of returning to target continues to hinge on wage growth. And wage growth continues to prove elusive despite some recent improvements.
The BoE identifies two opposing forces pulling labour costs to different directions. On the one hand, the upward impact of tightening labour market slack. On the other, the danger that lower inflation and wages expectations become entrenched and partly self-fulfilling.
Looking forward we will be closely monitoring any parameters that might impact inflation. EEF’s pay survey, which comes out a day after the inflation data next week, will give us an indication of pay changes in manufacturing. Savings ratio data released later this month by the ONS should also shed some light on the effect of energy prices on consumer behaviour.
In terms of global developments, we will be keeping a close eye on the oil market as well as the unravelling of events in the Eurozone. The latter is likely to continue to dictate exchange rate movements in the UK.