Global rates to rise in 2015? Not likely

The increasingly erratic actions of central banks, especially in the UK and US, suggest the market is overpricing the timing of the first rate hike and the degree to which rates will rise.

Federal funds futures for instance, imply the Fed will start hiking by June next year, with the overnight rate ending 2015 closer to 0.75 per cent. That's roughly three rate hikes. The Bank of England is expected to hike in the March quarter, taking the cash rate to about 1.25 per cent (from 0.5 per cent) by year’s end. 

That doesn’t sound too onerous, and it isn’t. A prudent central bank should have taken those steps several years ago. Even so, there a couple of signals being transmitted by central banks that suggest the global tightening cycle may not start until toward the end of 2015 or 2016 at the earliest.

Of the more bizarre signals, the seemingly confusing commentary from the Bank of England’s Canadian governor Mark Carney is an extraordinary development. One conservative MP noted that Carney had “given a lot of guidance, not all of it seeming to point in the same direction”. The question arises as to why the governor of the Bank of England has repeatedly given mixed and inconsistent signals to the market.

It’s an important question, as the art of central bank public relations or ‘communications policy’ is highly refined. The market doesn’t simply put this confused rhetoric down to a gaffe-prone L-plater, as they once did with Fed chair Janet Yellen’s similarly confused commentary. Especially as Carney was also head of the Bank of Canada for about five years. That Carney still remains as governor shows that he still enjoys official endorsement, notwithstanding his rhetorical acrobatics and criticisms from MPs on both sides of parliament. This suggests this confusion must enjoy official sanction from the government -- it has been going on for a long time.

Wage growth is at the centre of BoE’s latest communications foray. Earlier in the year, Carney said that markets were underpricing the risk of a rate hike and could be surprised by an early move. Indeed committee members had expressed surprised at the time that markets were only pricing in a low probability of a move in 2014. That position appeared to be reversed in the latest inflation report, when the bank seemed to imply that slow wage growth could delay a rate hike. The governor then said in an interview some days later that slow wage growth wouldn’t stand in the way of a rate hike.

There is nothing unusual in looking at wages. Wage growth has always featured in policy analysis alongside a large number of other indicators. In our current circumstances, the argument is that it’s prudent to look to wage growth to help clarify questions over labour market strength. Jobs growth in the UK and US is strong and unemployment rates are tumbling. But then again, labour participation is falling.

If labour markets are tight, then logically enough wage rates should start rising. That they’re not rising (or even falling) suggests more capacity than indicated by the unemployment rate. The obvious problem is that by the time wage growth actually starts to accelerate, inflationary pressures are already well established. It’s well known that wage growth lags the most important of the lagging indicators: the unemployment rate. 

The broader issue is that this new wage target is only one of a series of targets that have been dropped once met. The inflation target was the first, and both the Fed and the Bank of England dropped this early in the program when inflation rates were above their thresholds of comfort. More recently, both banks had an unemployment rate objective, again discarded when it became apparent that the targets were in danger of being hit. The Bank of England cleared the way; the Fed followed. This new wage target that was adopted by both banks must be seen in that broader context -- just one more Clayton's target (the target you have when you don't want to have a target) that will be ignored if it suits.

All of this strongly suggests that central banks (the Fed and the BoE) are just playing for time. They are constantly shifting the goal posts by using inconsistent rhetoric and choosing a variable noted for its long lags to the cycle as a key target. Remember this whole conversation is taking pace against record low interest rates. This isn’t a debate about whether monetary policy should be restrictive or not; even if cash rates were tripled they would still be highly accommodative.

I suspect a large part of the problem is that the world isn’t in a good position to deal with a genuine or sustained divergence in policy between the ECB, the Fed and the BoE. The volatility unleashed could have unpredictable and potentially dire consequences for the US and UK economies --  not something the UK government is going to want going into a general election in early to mid-2015.

Indeed a successful and smooth transition out of this ultra-loose monetary policy world will likely require central bank coordination. Yet the fact is the ECB is not even close to entertaining a rate hike. Recent data shows that growth has slowed and that inflation still remains subdued.  Until those changes, and given past behaviour, markets should and increasingly do hold a great deal of scepticism over any forward guidance provided by central banks. It's a lesson that should hold for the RBA as well.