While not quite performing a U-turn on his monetary policy views, Bank of England Governor Mark Carney attempted to prep the money market for an earlier policy tightening than was previously thought at an annual dinner in the City of London. The impact was to drive the British pound higher and within an ace of its highest level against the dollar in six years. At the same time, gilt or government bond yields tracked higher while the implied cost of borrowing three-month cash over coming years also surged along the yield curve.
Carney sent a cool-wind across financial markets when they opened on Friday after he told an audience the first rate hike “could happen sooner than the markets currently expect”. Ten-year British gilt yields, however, only added 2bps to 2.74% towards the close of trading. The speech prompted record volume in short sterling interest rate futures and options contracts according to the Intercontinental Exchange, which owns the LIFFE-traded contracts.
With growth picking up and the labor market healing, the Bank of England is also faced with a strong recovery in house prices. The government recently awarded the Bank tools to regulate the mortgage market, which it warmly welcomed.
The bank is generally concerned by widening distortions that may result from the same ultra-low policy setting as adopted by the Fed, ECB and BoJ. It still believes heavily indebted consumers would suffer if it raised rates too quickly or too far and as such, Carney was careful to emphasize that point.
While the price of short sterling futures tumbled in the aftermath of Carney’s speech, sending implied borrowing costs higher, the move appears pretty orderly. As earlier noted, the change in gilt yields ended up being quite subtle. And while the interest rate market brought forward its view on the timing of policy tightening, the yield curve remained relatively sanguine following Carney’s warning.
The biggest rise in implied borrowing costs was at the March 2015 expiration (+19bps), while March 2016 saw its implied yield tack on 15bps. But the March 2017 contract gained just 9bps. And so even as the Governor warms the interest rate market up to the prospect of its tighter stance sooner rather than later, the market appears to be taking the news well in its stride.