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The Bank of England’s Monetary Policy Committee will make its rate decision tomorrow and announce it on Thursday. Meanwhile, the Federal Reserve will step in and steal the limelight from Britain with its own rate announcement (whose meeting starts, to be fair, today). It will be the third time this year that this has happened and it is due to happen twice more before the end of the year.
Which decision is more important in determining the financial conditions of the UK? Probably that of the Bank, but not definitely.
In IMF Paper on Selected IssuesAgnese Carella, Ruo Chen, Katherine Dai, Gloria Li, Ruy Lama and Roland Meeks analysed this common daily conflict. Because, as they themselves expressed it:
…FOMC monetary policy decisions could affect UK domestic demand through their impact on the country’s financial markets.
The blue line in the chart below is taken from the report. It shows the yield on two-year government bonds in the days leading up to the Bank and Fed’s rate decisions in December 2023:
Readers will recall that on December 13, the FOMC sent a dovish signal to markets, hinting that they might cut three times in 2024. The two-year government bond, supposedly driven by expectations about what the Bank of England’s policy rate might do, fell 25 basis points at the open. When the Bank of England’s decision came out (a hawkish stance to hold the rate with three of the nine members voting for a further hike), yields rose a bit. But by the close on December 14, the Bank’s hawkish message was still not enough to offset the Fed’s dovish message, and two-year government bond yields closed 6 basis points lower that day.
As the IMF puts it:
Our results indicate that FOMC spillovers have a significant impact on monetary transmission in the UK.
Of course. I can think of several phases involving bears, Catholics, forests and the Pope. But the IMF is right that this is a very important issue, and a suboptimal one at that. To state the obvious, the Federal Reserve does not care much about the state of the UK economy when setting US monetary policy. And the timing of the MPC’s decisions and the communication of those decisions seem almost designed to ignore the impact that any Fed decision might have on UK monetary conditions.
Why is this important? The Monetary Policy Committee influences financial conditions in the economy (and through them the broader economy) through its ability to set the overnight bank rate. But only commercial banks have direct access to the bank rate. The bank rate influences the rest of us through market rates – the mortgage rates we pay, the savings rates we receive, and so on. If sterling market rates plummet or soar because Jay Powell feels more pessimistic or more optimistic about the future, this is important information for the Bank to take into account when setting policy.
The IMF believes that having the Monetary Policy Committee hold a press conference after each decision (as other major central banks do) would help with the transmission mechanism, but we wonder if perhaps moving the decision day to any of the 358 days of the year that do not follow Federal Reserve Day might be a simpler and more foolproof solution.
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