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When it comes to monetary policy – go with your gut

When it comes to monetary policy – go with your gut

Richard Conway Weekly bulletin September 2018

Compound-for-compound, wine is the most complex drink on the planet. Growers obsess about the minutiae of production, controlling and tweaking various aspects to get the most out of their crop. Whether it’s the type of fertiliser used, the right day to pick the grapes, whether to leave the stems on or just the grapes, oaked or unoaked –- there is an almost infinite number of variables that make a good wine.

Despite this complexity, it’s usually the uncontrollable elements that have the largest influence on the outcome; whether it was a dry or a damp summer, if the harvest was too close to the turn in temperature, whether the latest fungus has passed your crops by or not.

It’s much the same with monetary policy.

We live in a world where three of the major central banks are embarking on broadly similar courses of tightening. The US Fed has led the pack, the Bank of England has followed suit and while the European Central Bank is a little further behind, it promises to catch up soon. All agree that increasing rates first, followed by a trimming of the balance sheet, is the correct course of action.

Despite the similarities in their choices of action, each has been met with different results.

The US economy appears to be taking the medicine best. The Fed has been on a fairly steady course of tightening for a couple years, but growth remains resolutely robust despite the increase in the Fed Funds Rate. Non-farms last Friday registered a decent 201k, affirming that the labour market is in rude health, while Q2’s 4.2% annualised GDP is very encouraging (even if full year growth is closer to 3%, as is widely expected). Tax cuts have helped, but that can’t account for all of the recent outperformance.

Eurozone and UK economies have done less well by comparison. PMIs for the UK last week were far from a reference crop, with disappointing manufacturing and construction numbers keeping the lid on the composite figures, despite a slight pickup in services activity. Official figures for sectoral growth that came out this morning confirmed the lacklustre performance.

The papers are quick to pin the blame on looming Brexit talks, yet a glance across the channel would show that growth doesn’t look much better on the continent. PMIs and other leading survey data gives little cause for optimism, and while the ECB’s governing council intends to go ahead with their taper at the time of writing, one could see cause to delay further still.

All of which underlines the key uncertainties around policy.

Given the indirect links between policy instruments and the output variables for economies, commentators can argue ad infinitum on the appropriateness of any particular course of action. Volatile data often drives volatility in opinion.

Yet few would disagree that the era of easy monetary policy has probably gone on for long enough, and that there will always be cause to delay. In order to steer their economies back to normality and put themselves in good stead to head off any crises down the road, central bank governors are now – quite rightly – taking the lead from the head of the Fed.

Having previously been derided for his background outside of academia, Powell’s less rigid approach is now gaining favour. Governors are increasingly basing their decisions on feel, rather than (increasingly) conflicting data.

Policymakers are seeing value in keeping things more simple, and taking on the mantra to “go with your gut”. Given current levels of uncertainty, they’re likely all the better for it.

Upcoming data releases

UK wage growth data will be closely watched on Tuesday, as will the latest ZEW survey of economic sentiment for both Germany and the wider Eurozone. US producer price growth and Eurozone industrial production will both feature midweek, but it will be Thursday that is the main focus. Interest rate and asset purchase decisions are due from both the ECB and the BoE. No change is expected from either, but comments will be closely watched for hints of the next moves in each case.

For more information, please contact Richard Conway, Associate Director at Chatham, at rconway1@chathamfinancial.com.


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