There are two events this week that will shape the investment climate potentially for the rest of the year. The first is the Bank of England meeting. The following day is the US employment report.
Both events take on added significance. The Bank of England enters a new era. The Monetary Policy Committee meets as usual, but shortly after it, the minutes will be published, and this will contain the vote itself. There will no longer be a couple week delay. It will be interesting to see if other central banks, including the Federal Reserve and Bank of Japan adopt a similar approach over the medium term.
It took the European Central Bank more than a decade to see the wisdom of providing some record. It may be too much to expect it to make it nearly immediately available.
Also, the BOE will release its Quarterly Inflation Report at roughly the same time. This report has become an integral part of assessing the policy stance. From giving little information at the time of the MPC meeting, the BOE is going to deluge the market with information. It will dominate August 6 but on what should investors focus?
Two considerations will ultimately generate the underlying signal for investors. The first is the vote itself. Many observers expect three MPC members to dissent: Weale, McCafferty, and Miles. If any more dissent, sterling's reaction is likely to be more pronounced, and the impact on UK rates may be dramatic. It would drive home what has been a tail-risk, namely a November rate hike. On the other hand, this is Miles' last meeting. His vote might be dismissed by investors, as his successor, Gertjan Vlieghe, has wisely not shared his views.
The second consideration is the quarterly inflation forecast of inflation on a two-year time horizon. If it is on the inflation target (2.0%), it will reaffirm market expectations for a hike in late Q1 15 or early Q2. Above the inflation target would be seen as a signal of an earlier lift-off. In this context, the BOE may not just lift the upside, but it may downplay the downside risks, now that the Greek drama is somewhat less urgent.
The monthly US jobs data is the most important of the high-frequency reports. The July report that will be released on August is exceptionally important. It follows the FOMC statement that called job growth “solid,” and appeared to lower the bar for a hike by modifying the continued improvement in the labor market with the word “some.” Provided that the US economy continued to generate a net of 200k+ jobs in July that qualification would have been met.
The other reason the employment report has added significance is that a robust report would help neutralize the effect of the record low rise in Employment Cost Index reported on July 31. Most of the volatility in the report is coming from commissions and bonuses. Excluding those with incentive pay, the employment cost index was 2.0% in both Q1 and Q2.
We suspect the investors and observers misunderstand how wage growth fits into the FOMC's reaction function or its policy-making equation. Simply, if crudely put, wage growth would be a helpful confirmation of the absorption of labor market slack, but it is not a necessary precondition for a rate hike.
Yellen is plain spoken, and she could not have spoken more plain: “I have argued that a pick-up in neither wages nor price inflation is indispensable for me to achieve reasonable confidence” that inflation will reach the Fed's target in the medium term.
