Indeed as the Bank of England pointed out in the minutes from its most recent monetary policy committee meeting, this pessimism was in evidence in the overnight swap index, which was now only pricing in a hike in rates in July 2015, two months later than previously, and later than the majority of respondents to a Reuters poll.
“After the first increase, the path of the bank rate implied by OIS rates had remained shallow and the implied level of bank rate in three years’ time was a little under 2%,” it said.
And, if the dovish tone of the latest set of minutes from the Bank of England’s monetary policy committee is anything to go by, that optimism – especially in terms of the timing of the first rate hike – may not be back any time soon.
According to the BoE, while the pace of the recovery in both the UK and the US has been maintained, “pessimism about the global economic outlook had increased over the month.”
“Partly this was a reflection of geopolitical risks in the oil-producing regions of the Middle East and continuing tensions between Russia and Ukraine. It was also due to the steady accumulation of evidence that the outlook for the global economy had weakened, particularly in the euro area and many emerging economies,” it said.
It is a pessimism that also seems to be felt still by most members of the MPC, although the same two members that had previously voted to hike rates 25 basis points continue to be of the view that raising rates now is the best course of action.
For the seven doves on the committee, however, the BoE said that while they acknowledged that the bank rate remains exceptionally low: “there remained few signs of inflationary pressure in the UK economy, even after looking through the effects of a stronger sterling exchange rate.”
And, importantly, the Bank said: “While the economy had been growing sufficiently quickly to absorb some of the slack in the economy, there were some signs that the pace of growth was beginning to ease. The housing market appeared to be cooling with house price growth slowing to a more sustainable pace. Further downside news in the euro area had increased the risks to the durability of the UK expansion in the medium term.”
And, it added: “Those headwinds were likely to mean that the real rate of interest consistent with stable inflation over the medium term was likely to be lower than in the past, even after slack had been absorbed. Consistent with that, global real interest rates at longer maturities were significantly lower than before the crisis and had fallen further. A premature tightening in monetary policy might leave the economy vulnerable to shocks, with the scope for any stimulus that subsequently became necessary being limited by the effective lower bound on Bank Rate.”
It is clear from the statements above that the majority of the BoE’s MPC members are more concerned with the prospect of further disinflation or worse, deflation, rather than imminent inflation, and they are not alone – there area number of investors of the belief that economic growth is going to be much more challenging than initially thought.
Neil Woodford, for example, said in a recent commentary on the Woodford Funds website that, while the correction seen in recent weeks was a healthy one: “On a three to five year view, the world economy faces a challenging future.
However, there are those, like Russ Koesterich, BlackRock’s Global CIO, who believe that while investor sentiment has clearly shifted, economic fundamentals remain “relatively stable” which suggests that “the recent sell-off in stocks could present opportunities for long-term investors.”
“The good news is that despite the stock market sell-off, investors do not appear to be panicking. Global exchange traded products saw inflows of $10.9 billion last week. Granted, investors sold higher-risk European and emerging markets equities while continuing to buy Treasuries, but not all the flows were defined by risk aversion. Both U.S. large- and small-cap stocks gathered assets.”
Koesterich added: “We continue to favor large- and mega-cap stocks. They have held up better than their small- and mid-cap counterparts in the last few weeks, providing a bit of cushion from the volatility. And with the recent sell-off having made them more attractively valued, we suggest investors continue to emphasize larger capitalizations, particularly with more volatility likely on the horizon.”
