The Inscrutable Bank of England

Welp, after Bank of England (BoE) Governor Andrew Bailey seemingly went to great pains in recent weeks to signal the BoE would raise its benchmark short-term interest rate Thursday, it didn’t. Coverage we follow suggests this is the kind of action that led one Member of Parliament to dub Bailey’s predecessor, Governor Mark Carney, an “unreliable boyfriend.”^[i] Similar chatter to that abounded following Bailey’s post-non-hike press conference.^[ii] For investors, we think this illustrates why you shouldn’t take monetary policymakers’ suggestions about future actions—their “forward guidance”—at their word.

Whilst Bailey said the BoE’s decision to keep its Bank Rate on hold at 0.1% was a “very close call,” the Monetary Policy Committee’s (MPC) 7 – 2 vote seemingly belies that.^[iii] The MPC also voted 6 – 3 to stick with the previously announced December end to increasing its gilt holdings under quantitative easing (QE, monetary policy institutions’ asset purchases intended to reduce long-term interest rates and spur loan demand), eschewing calls for a quicker cessation from some analysts we follow.^[iv]

Normally, policy meetings with no changes are a snoozefest to us. But this one left many commentators we follow shaking their heads. Less than a month ago, Bailey warned that the BoE needed to prevent higher inflation expectations from becoming entrenched as energy prices spiked.^[v] As he put it, “That’s why we, at the Bank of England have signalled, and this is another signal, that we will have to act. But of course that action comes in our monetary policy meetings.”^[vi]

Yesterday? Nothing. Bailey wasn’t even amongst the two who voted to hike rates!^[vii] The BoE now says it will likely raise rates “over coming months” (December? February? Further out?), but in a move we find typical of monetary policy institutions, it left itself an out.^[viii] That nebulous time frame assumes “... the incoming data, particularly on the labour market, are broadly in line with the central projections in the November Monetary Policy Report.”^[ix] But we don’t even think this is so ironclad. Even if data over the next month or three conform exactly to their projections, they can always change their minds. As we think the latest decision makes clear, MPC members’ opinions—like Bailey’s—come and go. Or something else could come along—say, energy prices falling versus recent spikes.^[x]

In our view, it would be great if monetary policymakers did what they said without ambiguous, impossible-to-decipher conditions. But that often isn’t the case, in our experience. To see this at work, we think you can compare markets’ reaction to the US Federal Reserve’s (Fed’s) QE reduction (aka taper) announcement Wednesday against the BoE’s surprise yesterday. The Fed has telegraphed for months that it would taper QE at the November meeting.^[xi] It didn’t outright say so, of course, but we think it strongly hinted as such and did nothing to step back from that pre-meeting.^[xii] So when it tapered Wednesday, markets basically yawned, in our view. 10-year US Treasury yields rose 4 basis points on the day, a rounding error to 1.59% from 1.55%.^[xiii]

By contrast, when Bailey’s actions appeared to undercut his own words, bond markets swung much more materially: 10-year gilt yields fell -14 basis points to 0.93%—its biggest one-day move all year.^[xiv] Shorter-term yields fell even more. The 2-year fell -21 basis points to 0.46%, and the 1-year dropped -24 basis points, almost halving, to 0.25%.^[xv] (Exhibit 1) These moves reverse climbs since late September—climbs that amounted to markets pre-pricing Bailey’s faux-hawkish stance, in our view.

Exhibit 1: When Short-Term Gilt Yields Stop Believin’

Source: FactSet, as of 5/11/2021. 1-year gilt yield, 1/1/2020 – 4/11/2021.

We often highlight our view that surprises move markets most. Whilst the BoE’s not hiking wasn’t an enormous shock in the grand scheme of things, in our view, it wasn’t what markets expected, either. Many traders, seemingly thinking the bank would defend the credibility of its forward guidance with action, bid up yields in recent weeks. But this didn’t occur. Confounding market expectations consistently could erode the monetary policy institution’s credibility, which loads of commentators we follow argue would be bad. But in our view, there isn’t any evidence monetary policymakers’ forward guidance was ever credible to begin with. Hence, we think you are best served discounting it now.

Our advice: Don’t hang on monetary policymakers’ every word. Our historical research shows markets don’t hinge on them; they don’t demonstrate any preset reaction to whatever monetary policy committees decide. Rather than trying to divine policymakers’ intentions, we think it is better to just wait. See what they do, and try to assess whether that has any discernible effects. There will be time to decide what—if anything—needs doing, in our view.