MNI INTERVIEW: Gilt Hit Weighs On Inflation - Ex-BOE Saunders
MNI (LONDON) - The sharp rise in gilt yields looks set to lower the Bank of England Monetary Policy Committee's collective inflation forecast in February, signalling more easing than markets have been pricing in, former MPC member Michael Saunders told MNI.
While MPC members may disagree over whether the yield shock has an external or internal cause, the MPC as a whole is likely to come to the view that it is due a mix of endogenous and exogenous elements, lowering the inflation profile and implying that recent market pricing pointing to just two rate cuts in 2025 is implausible, said Saunders, who left the BOE in 2022 and is now at Oxford Economics.
"It'll be viewed as a mix of both, but not wholly endogenous. So as long as you view it as partly exogenous, then you end up with a weaker inflation outlook," he said in an interview. “If it's an exogenous shock, then that's relatively easy. It's just interest rates up, growth down, inflation down.”
If the shock is endogenous, however, reflecting U.S. fiscal stimulus, for example, then the MPC has to assume additional factors such as higher global growth.
This uncertainty over the cause of higher yields is likely to mean the MPC cannot just use a standard multiplier to model the impact of higher market rates on inflation and activity in its forecasts, which are based on "best collective judgment," according to Saunders. (See MNI INTERVIEW: UK Budget Investment Spending To Curb Rate Cuts)
MIXED CAUSES
"The difficult bit is whether, if yields are higher, have you got to build in an extra something for growth momentum or inflation stickiness as an offsetting factor? That's why you can't ... just assume a standard multiplier always is the answer.”
More hawkish and dovish members could take opposing views of the gilt shock.
Catherine Mann, for example, who has so far opposed any rate cut, could take the view that "this rise in interest rates is just because markets are coming round to my view... of inherent inflation stickiness," while Swati Dhingra, who has championed a lower policy rate, could say it was an exogenous shock and that she was "even more convinced that we need to cut rates quickly,” according to Saunders. (See MNI INTERVIEW: UK Budget Ups Inflation Pressure - OBR Miles)
In Saunders' view, the recent market rate path, with only a couple of rate cuts this year, has been implausibly high.
"The way in which you would get there would be that inflation turns out higher than the MPC expects. So what we saw in the October and November CPIs, less so in the December one, is a recurring feature in the coming year ... markets seem to be implying that the inflation stickiness of those couple of months will persist. Personally, I doubt it.”
NO FISCAL DOMINANCE
If the MPC presses ahead with rate cuts it could be accused of helping the government deal with higher debt interest costs, but Saunders rejects this argument.
"In order for that view to carry weight, what you'd have to see is, a) markets priced in a rate cut, and b) inflation expectations are rising, and probably c) sterling is falling significantly, trade weighted, more than other currencies. In other words, markets say we think you're going to cut rates, but we think it's the wrong thing to do, right? And I don't see evidence of that, and as long as you don't, then I doubt if that risk would carry much weight with the committee. It's like you're just worrying about things for which there's no evidence," he said.
The Bank could, in extremis, postpone an upcoming gilt auction if there was excessive turbulence but the vast majority of quantitative tightening in 2025 is set to be come through the maturity of its holdings, rather than through active sales.
"I think they won't postpone it ...[but] the hurdle for postponing it is a bit lower," Saunders said.
"It's not quite as big a deal, because everyone knows that most of the QT will happen anyway," he said, adding that any suspension of sales would risk fuelling unnecessary alarm.
"It would just raise questions about, 'gosh, if they're having to postpone it, is there something going on that's worse than we thought?' ... In terms of their rate decision, one of their aims will be that the Bank of England itself should not be a cause of uncertainty, and that the same thing applies to the decision over whether to postpone that QT. If they postpone it, would that head to uncertainty? It might.”