BoE sees signs of re-leveraging – HSBC

Analysts at HSBC suggest that the required or equilibrium real rate is influenced by changes in risk-taking behaviour, a point made in a recent speech by BoE MPC member Gertjan Vlieghe, which means that even in a low r* world there can also be a cyclical element.

Key Quotes

“Previously, he had always argued that in such a high debt economy, very low real interest rates needed to be in place to assist the deleveraging of much of the post-crisis period. But in his recent speech, he argued that the recent halt or pause in deleveraging, indicated that households had reached their desired debt-to-income ratios and that deleveraging was no longer weighing on demand as much. He suggested that this might mean the equilibrium real rate is rising slightly from the very low levels of the post-crisis period and went on to hint that it might be appropriate to raise rates in the coming months.”

“The UK, because of the slide in sterling post the Brexit vote, is currently displaying a very different inflation picture to the rest of the developed world. Wage growth is similarly subdued but inflation is well above target following the slide in sterling post the Brexit vote. The BoE will have to try to gauge whether it is supply or demand that is being most negatively affected by the Brexit process.” 

“But the comments on risk-taking and leverage are interesting and illustrate a way in which central banks’ view on the appropriate rate has started to shift. One of the main intentions of QE back in 2008 was to boost asset prices. Negative interest rates also encourage individuals to take on more risk rather than face a guaranteed loss. Now the current expectation that central banks will continue to adhere strictly to their inflation targets and therefore keep policy loose is encouraging the hunt for yield – so much so that a further increase in risk appetite may no longer be desirable. If so, a higher policy rate may be required to prevent the current policy setting from being too expansionary. Already other smaller developed economies where growth is more robust, seem to be seeing a shift in attitudes towards their inflation-targeting regimes in response to growing financial stability concerns.”