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The Bank of Japan moved first last week, raising its main interest rate from about 0.1 per cent to 0.25 per cent early on Wednesday morning, with hawkish language about the future and a new focus on the yen.
The Fed surprised very few people by holding its main rate at 5.25 to 5.5 per cent later on Wednesday, but signalled a cut in September. The next day, the Bank of England voted 5 to 4 to cut rates by a quarter point to 5 per cent.
Three different policies, but I noticed seven themes.
1. Some meetings are more important than others
With hindsight, the BoJ’s meeting was pivotal, while the Fed and BoE meetings were merely interesting. In Tokyo, the hawkish move to raise rates, the focus on the yen and the guidance that more rate rises were coming this year surprised almost everyone.
The market reaction and the lightning quick unwinding of carry trades will have surprised the BoJ. None of it looks very clever six days on. For sure, Japanese wages grew strongly in June, bolstering the BoJ’s case, but when you pull on a piece of elastic tied to a brick, at some point it will smash you in the face. I am sure the BoJ did not intend to generate the reaction it caused, even if some of the market movements were clearly excessive.
In contrast the Fed and BoE meeting outcomes were either exactly as expected or close to expectations and cannot easily be blamed for the subsequent market turmoil. Even though the FT was able to find lots of people to be beastly about the Fed on the record on Friday, they were quite quiet until the markets puked.
2. A shift towards forecasts from data
In a timely response to last week’s newsletter, central bankers are putting more emphasis on their forecasts again and less on individual pieces of data.
The Bank of Japan justified its rate rise saying that, “economic activity and prices have been developing generally in line with the outlook presented in the previous Outlook for Economic Activity and Prices”.
At the BoE, there was a similar shift among the five members voting for a cut. Clare Lombardelli, the new deputy governor for monetary policy, spoke for the majority when she said the UK economy “is evolving broadly in line with [the BoE’s] expectation, and that gives you more confidence that you’re in this world where inflationary pressures are reducing”.
Jay Powell, Fed chair, struck a slightly different tone, still sticking to the line that he wanted to see more data to add to the comfort that inflation was falling, but again officials in Washington think the economy is evolving in a way that meets its dual mandate of stable inflation and maximum employment. Obviously, this came ahead of Friday’s poor jobs data and the September rate cut is even more nailed in place now.
3. Casting the data net more broadly
A big shift across all central banks has been to look at what Powell called “the totality of the data”. He also copied ECB president Christine Lagarde’s phrase, saying the Fed would be “data dependent, but not data point dependent”. The BoE ditched its previous focus on the labour market, wage increases and services prices, replacing these with a focus on “a broad range of indicators”.
The BoJ had been a bit sniffy about talking exchange rates, but noted last week that import prices were rising again and this warranted “attention”. There is no doubt that the hawkish language deployed by the BoJ has helped turn around what seemed to be a persistent slide in the yen. The problem is that it got more than it bargained for.
4. Interest rate turning points are manageable
There was a fear in central banks that the first move in interest rates would have an outsized effect on markets. This was initially dispelled by the European Central Bank’s well-flagged cut in June, which was met with little action.
You might think that the extreme volatility proves me wrong. But the chart below shows there was less movement last week in sterling forward interest rates than in those from the US. For sure, it showed quite a large movement, but this was more a widespread reaction to the US than anything UK specific. Well explained rate moves do not necessarily cause market to expect a huge reversal.
5. Politics and central banking is entwined and messy
There were certainly suspicions that the Japanese government lent on the BoJ to raise rates early in a bid to defend the yen last week. That went well. Elsewhere, things were no easier.
BoE officials had to talk about how the new government’s revelation of a large public sector overspend would affect policy. The answer from the BoE was that it did not enter into their thinking in last week’s meeting and they would think again in their next forecasts. I can remember only two times — shortly after the 2010 election and in the wake of Liz Truss’s disastrous “mini” Budget in 2022 — when the BoE has actually said that fiscal policy was affecting its thinking. Normally, it finds an excuse to dismiss the idea, messy as this is.
Jay Powell skillfully avoided the US election issue, stating that it was not affecting the decision-making process for a September rate cut. He made it clear that the Fed was not anticipating any changes in economic policy, hinting at a forecast based on a Harris victory without explicitly stating so.
Scenarios still have a long way to go before they become useful tools. The Fed could benefit from openly discussing how it would react in different circumstances, such as a Trump victory, to provide transparency on its decision-making process. However, Powell refrained from delving into this topic, emphasizing that the Fed does not consider the economic policies of different candidates in its models.
Central bankers, including Powell and Bailey, are struggling with providing clear guidance to the public. Powell’s repeated clarification that no decision had been made regarding a September rate cut gave the impression that a decision had already been reached. Bailey’s reluctance to define the statement about not cutting rates “too much or too quickly” highlights the challenges central banks face in effectively communicating their intentions.
The Bank of England’s approach contrasts with the Bank of Japan’s clear and hawkish guidance, which was met with negativity from financial markets. This underscores the complexities of central banking and the challenges of striking a balance between transparency and market reaction.
The article also touches on various economic issues, including the impact of sanctions on Russia, the volatility of the yen, and an experiment with digital currencies in Thailand. It concludes with a discussion on the Sahm rule and its implications for the US economy, highlighting the challenges of interpreting economic indicators in the current climate.
Overall, the rewritten content maintains the key points and structure of the original article while providing a fresh perspective on the challenges facing central bankers and the global economy. following sentence:
The cat calmly watched the bird from the window sill.
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