As the Bank of England publishes its quarterly inflation report, Mark Carney faces a big test as markets wait for his first stab at forward guidance - he must walk a fine line, says CMC markets analyst Michael Hewson.
LONDON, ENGLAND, UK (AUG 07, 2013) (REUTERS) -
JOURNALIST ASKING MICHAEL HEWSON: "I just want to step back before we get into exactly what you think Carney's going to do. All the wow's and amazing's and these other superlatives that we've seen on the front of the papers describing the UK economy, do you buy that?"MICHAEL HEWSON: "Not really, Axel. I mean, I think you've got to look at it in the context of where we've been over the past five years. I think if you look at it in the context of that, then yes, the economic data is very good. But you're taking it from a very low base. We've been used to an awful lot of disappointment over the past five years. Now, six months ago, we were talking about a triple dip recession. No one's talking about that now. The last quarter or the first quarter of this year, 0.3%, second quarter, 0.6% potentially could be revised up to 0.7% and we got off to a very good start for Q3. The question is, is it sustainable given the fact that consumer incomes still remain very, very squeezed. You look at average earnings, they're around about 1.8% but inflation is around about 2.9%."
JOURNALIST: "So, you're saying Carney would be wise to guide to the market to consumers to manufacturers that rates are going to stay low for a good two years?"
HEWSON: "Well, maybe not as long as two years but maybe a year because I think the problem with an economic recovery is interest rates have a tendency to nudge higher naturally in any case because essentially, you're talking normalization and I think what he wants to be very, very cautious about is driving an asset bubble. You've only got to look at the rise in house prices and really ask yourself, do you really want to start lighting a fire under them, given that they were precisely the cause that got us into this mess in the first place. So he needs to really, I think, walk a very fine line between not appearing too hawkish because essentially, I think he's going to revise his growth forecast up while revising inflation downwards. But also not appearing too dovish and pushing the Pound lower because you look at all the economic data that we've seen over the past few days, the Pound hasn't really moved and yet the Euro is higher. And you're not seriously telling me that the European economy is doing better than the UK."
JOURNALIST: "Where is the market going to feel this?"
HEWSON: "I think we're going to see this in the foreign exchange markets. I think the fact is, I think markets are very concerned about being long of Sterling. So I think what we don't want to see is a sharp sell-off in Sterling and that could fuel inflation especially if we drop below 1.50. At the same time, he needs to keep the exchange rate stable while at the same time, giving confidence to consumers and the public that interest rates aren't going to suddenly shoot up unexpectedly."