The Bank of England (BoE) raised rates 50bp in line with consensus to 1.75%, despite publishing a grim set of economic forecasts including recession.
There wasn’t much in the way of dissent, but one Monetary Policy Committee (MPC) member (Tenreyro) wanted to raise rates only 25bp.
The decision to hike remains all about inflation, with an emphasis on domestically-driven inflation: “The labour market remains tight, and domestic cost and price pressures are elevated. There is a risk that a longer period of externally generated price inflation will lead to more enduring domestic price and wage pressures”. The decision is certainly not a response to changes in their growth outlook as their forecasts assume a recession: “The United Kingdom was now projected to enter recession from the fourth quarter of this year.” In his comments, Governor Bailey talked about increased signs of domestic inflationary pressure, mentioning a broadening out of inflationary pressure and that companies were finding it easier to raise prices (businesses are apparently reporting to them that they can pass on cost increases and aren’t meeting much resistance), justifying the more ‘forceful’ 50bp rate rise.
Their guidance paragraph gives little away about the future path of rates, beyond this will be data dependent: “The MPC will take the actions necessary to return inflation to the 2% target sustainably in the medium term, in line with its remit. Policy is not on a pre-set path. The Committee will, as always, consider and decide the appropriate level of Bank Rate at each meeting. The scale, pace and timing of any further changes in Bank Rate will reflect the Committee’s assessment of the economic outlook and inflationary pressures. The Committee will be particularly alert to indications of more persistent inflationary pressures, and will, if necessary, act forcefully in response.” Governor Bailey mentioned that the faster pace at yesterday’s meeting will help bring inflation back to target sustainably, but said that does not mean they are now moving to a path of 50bp a meeting, or any other path. He said all options were on the table for their September meeting and beyond that.
Their forecasts potentially tell us a bit more: Forecasts “show very high near-term inflation, a fall in GDP over the next year and a marked decline in inflation thereafter”. CPI (Consumer Price Index), in their central projection “was expected to rise more than forecast in the May Report, from 9.4% in June to just over 13% in Q4 2022, and to remain at very elevated levels throughout much of 2023, before falling to the 2% target two years ahead.” The MPC are assuming a 75% increase in the Ofgem energy price cap in October. Beyond two years, however, inflation comes down well below target to 0.8% by the three-year ahead mark. Taken at face value, that probably means the MPC would (at the moment) envisage tightening a bit less than the market profile for interest rates which is built into their forecast – that profile has the policy rate at 3% a year from now, then falling.
They are, however, “putting less weight on the implications of any single set of conditioning assumptions and projections”. Other sets of projections support the initial conclusion though. In an alternative projection where energy prices follow their futures curves throughout, two-year-ahead CPI inflation is well below target at 0.9%Y (and only 0.3%Y three-years ahead). In their forecast with constant interest rates, inflation is still above target at 2.5%Y in two years consistent with them envisioning tightening rates somewhat further, though even then the inflation forecast is well below target at 1.3% in two years. Even in their projection assuming greater persistence in domestic price setting, which has CPI inflation nearly a percentage point higher than the base case in two years time, the forecast is well below target three years ahead.
My forecasts have the BoE hiking to 2.25% (but not cutting rates thereafter). Yesterday’s decision, MPC commentary (including observations of what they are hearing from businesses) and – to a lesser degree – their forecasts are consistent with the risk to this forecast being on the side of a higher peak for rates and reaching 2.25% sooner, but needing to then cut rates. The overall outlook for the UK real economy remains downbeat, though my forecasts are not as grim as the Bank’s (see A new base case: Even less growth).
Active quantitative tightening (QT)
On active QT, the Committee had asked the staff to work on a strategy for bond sales. In summary, the proposed bond reduction programme would begin after the September meeting at a pace of £10bn a quarter (alongside maturing gilts they would expect this to reduce the stock of gilts held by £80bn over a 12-month period). The programme would take place under the principles that: “First, the Committee had a preference to use Bank Rate as its active policy tool when adjusting the stance of monetary policy. Second, sales would be conducted so as not to disrupt the functioning of financial markets. Third, to help achieve that, sales would be conducted in a relatively gradual and predictable manner over a period of time”. In line with the latter, “The MPC agreed that there would be a high bar for amending the planned reduction in the stock of purchased gilts outside a scheduled annual review”. They are “provisionally minded” to go ahead with Gilt sales in September, but there will be a confirmatory vote at that September MPC meeting.
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