The Bank of England’s Monetary Policy Committee will meet Thursday to decide whether to pull the trigger on interest rate hikes.
Policymakers have intimated that a hike is imminent, but the nine-member MPC will need to determine whether to tighten policy this week or wait until its mid-December meeting, in light of persistent above-trend inflation and moderating growth.
Markets are uncertain about the timing, with analysts suggesting the vote is likely to be split. Some BOE policymakers, such as Governor Andrew Bailey and renowned hawk Michael Saunders, have hinted that they could back an immediate hike, while others have seemed more reluctant.
Silvana Tenreyro signaled recently that she would need to see further labor market data following the end of the U.K.’s furlough scheme on Sept. 30 before voting to begin the path toward policy normalization.
At Monday’s close, market data showed that derivatives traders were pricing in a 64% probability of a 15 basis point rate hike this week, Berenberg highlighted in a note Tuesday. Senior Economist Kallum Pickering said that while his team considers a first hike in December “slightly more likely,” a move this week would not come as a surprise.
Pickering noted that an increase to the base rate of 15 basis points from its current historic low of 0.1% would keep monetary policy ultra loose, but may have a significant impact on rate expectations, which have shifted dramatically over the past month.
“Having brought forward the first hike from March 2022 to November 2021 since the start of October, the market now looks for the Bank Rate to rise to 1.25% by end-2022 followed by 40 bps in cuts from mid-2023 to end-2025,” he said.
“In essence, the market seems to expect a BoE policy error in the coming years in the form of an over tightening in 2022 that needs to be corrected with modest rate cuts thereafter.”
As such, Berenberg believes a first move on December 16 and an increase to 0.75% by the end of 2022, with further hikes in 2023 taking the Bank Rate to 1.25% around a year later than current market expectations.
Whether or not the Bank hikes rates on Thursday, Berenberg expects the MPC to send a clear signal in its forward guidance.
The path to tightening is complex
Central to the MPC’s headaches is the unique nature of the pandemic recovery, in that policy stances can shift as incoming data evolves, particularly with regards to growth and inflation.
British inflation slowed unexpectedly in September, rising 3.1% in annual terms, but analysts expect this to be a brief respite for consumers. August’s 3.2% annual climb was the largest increase since records began in 1997, and vastly exceeded the Bank’s 2% target.
GDP grew 0.4% in August after an unexpected contraction of 0.1% in July, as staff absences linked to the Covid-19 Delta variant surged.
“Like other major economies, the U.K. is experiencing significant supply bottlenecks and a highly uncertain inflation outlook due to conflicting signals between indicators,” said Gurpreet Gill, macro strategist for global fixed income at Goldman Sachs Asset Management.
High job vacancies indicate a tight labor market that is supportive of higher wage growth, Gill highlighted, while hours worked and labor force participation rates suggest significant spare capacity. U.K. job vacancies hit a record 1.1 million in the three months to August, while the average unemployment rate fell.
What’s more, a nosedive in immigration following Brexit and the pandemic could facilitate longer-term strains on labor supply in the U.K. compared to other major economies.
“Going into the upcoming MPC meeting, all eyes will be on the incoming data – including inflation expectations and business sentiment,” Gill said.
“The path to monetary normalisation is unlikely to run smooth, when the data on which the MPC makes decisions is highly changeable.”
Whether the first tightening of the policy screw comes on Thursday or in December, analysts are broadly in agreement that market expectations mean the Bank needs to follow through on a hike this year.
Michel Vernier, head of fixed income strategy at Barclays Private Bank, said the BOE’s expectations for inflation to rise to 4% may need to be revised up, with supply chain obstacles appearing stickier and energy prices exerting continued upward pressure.
However, Vernier said inflation is still “very likely” to moderate quickly, once the pandemic-induced output gap has closed.
“Inflation would now also be capped by early hikes, which may leave the possibility for the BoE to even reverse their decisions at a later stage if persistent excessive inflation does not materialise,” he said.
“The BoE’s recent comments on the urgency to act indicates that there seems to be a stronger emphasis on protecting consumers from higher inflation (GFK consumer sentiment recently consolidated, higher mortgage rates could provide further pressure).”