Economic comment: BoE hike 75bp despite a grim forecast economic outlook

As expected, the Bank of England (BoE’s) Monetary Policy Committee (MPC) hiked rates 75bp (going against the recent central bank grain by speeding up the pace of rate hikes) to 3%. The vote wasn’t unanimous though and dissent was all in a dovish direction with one vote for 50bp and one for 25bp.

They signal more rate hikes to come, but not as many as the market has priced in: They indicate though that further rate increases (plural) are likely to be necessary: “The majority of the Committee judges that, should the economy evolve broadly in line with the latest Monetary Policy Report projections, further increases in Bank Rate may be required for a sustainable return of inflation to target, albeit to a peak lower than priced into financial markets”.

There are a few important subtleties buried in that key sentence though, not least 1) The assumptions they’ve made in their economic forecasts (including on fiscal policy); and 2) what they mean when they talk about the peak priced into financial markets.

Firstly, they build into their forecasts a more supportive fiscal backdrop – which might seem a bit jarring given press reports recently on what the Chancellor will announce in the Autumn Statement. So, what are they talking about?

• Their working assumption is that there is some further fiscal support on energy bills beyond the next six months.
• They describe “other fiscal measures announced up to and including 17 October” as supporting demand relative to their August projection. They are making a comparison to the situation in August, rather than post mini-budget. They list the measures they have incorporated, which are effectively the bits of the Truss tax cut agenda that the Chancellor did not reverse (at least not so far) as well as the energy bill freeze: The cut in NIC’s/cancellation of the Health and Social Care Levy and changes to Stamp Duty.
• They are clear that they do not incorporate any further measures that may be announced in the Autumn Statement. In other words, the fiscal backdrop that they will incorporate by the time of the next meeting (and, more thoroughly by the February meeting when they will next publish forecasts) could be less supportive.

Clearly, if the 17 November Autumn Statement includes a significant amount of additional fiscal tightening measures, that suggests the MPC’s expectations for the path of the economy and interest rates may change again. However, it will be important how front and back-loaded any additional tightening is. Broadbent in the press conference made the point that what will matter to them are the effects of fiscal policy within their forecast horizon. In other words, a government tax hike/spending cut planned in fiscal year 2025 isn’t going to have much of – if any – impact on the BoE’s calculations.

It wasn’t immediately clear exactly which market peak they were saying is too high: They were unusually clear that they expect rates to peak lower than the peak markets have priced in. However, they referred to at least three market peaks. First, and likely most relevant given the context of the sentence, they refer to the peak they have incorporated into their forecasts (based on an average in the build up to finalising their forecasts) of 5¼ %. However, in the minutes, they noted that “in the immediate run-up to the MPC’s November meeting, market-implied expectations for the path of Bank Rate had peaked at around 4¾%”. Then in the press conference they acknowledged that the market is currently pricing in less than that again.

They are hiking into what they acknowledge as a “very challenging outlook for the UK economy”. Their forecasts for the economy remain very grim, with 2023 Gross Domestic Product growth at -1½% and 2024 at -1%. They have the unemployment rate at 6.5% by 2025. Recall though that the BoE forecasting a recession is not a new development today and their forecasts have been relatively grim for some time.

Does it make sense then to expect any more hikes from them at all? Even in the version of their inflation forecasts that assumes constant interest rates (at 3%), Consumer Price Index is only a little above target in two years’ time and more than a percentage point below at the end of the third year of the projection. However:

• They signal that is what they are likely to do, albeit with important caveats and cautious use of language (“further increases in Bank Rate may be required for a sustainable return of inflation to target”)
• They describe the risk around their inflation projections as skewed to the upside “in part reflecting the possibility of more persistence in wage and price setting.” They have seen “continuing signs of firmer inflation in domestic prices and wages that could indicate greater persistence”. In his opening statement at the press conference, Governor Bailey said that “This upside skew has important implications for monetary policy” and said that it is not least for this reason that the Committee judge further rate increases may be necessary.
• When describing what monetary policy is trying to do, the opening section of the minutes also includes the line that “Monetary policy is also acting to ensure that longer-term inflation expectations are anchored at the 2% target.” According to the minutes, “Business and household measures of inflation expectations had remained elevated, albeit that some indicators had ticked down more recently”.

Overall the decision, forecast and minutes today are consistent with downside risk to my forecast peak for UK interest rates at 4.5%. However, with domestically driven inflation pressures still looking relatively strong and fiscal policy uncertain, the skew of risk to my forecasts may change again before the end of the month.

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