Bank of England: Two voted against the 50bp hike… but they’re still likely to hike again

As expected, the Band of England’s (BoE) Monetary Policy Committee (MPC) hiked rates 50bps (slowing the pace of hikes from the 75bps they’d upped the pace to in November). Bank rate is now 3.50%.

The vote wasn’t unanimous, but dissent was in a two-way direction (Mann wanted a 75bps hike and Tenreyro and Dhingra wanted rates unchanged).

The forward signal on rates is similar in the statement to the November meeting, but they dropped the reference to the market having too much priced in:
“The majority of the Committee judged that, should the economy evolve broadly in line with the November Monetary Policy Report projections, further increases in Bank Rate might be required for a sustainable return of inflation to target.”

(Previously: “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.”)

Having signalled before that the previous peak for rates priced into markets was too high, can we read much into the fact they’ve dropped that reference? i.e. are they now happy with what the market has priced in/see it as consistent with their forecasts? In the build up to the meeting, peak market pricing was for a terminal rate of around 4.50%. It is wise never to read too much into changes in BoE wording… They may regard 4.50% as too much, but not egregiously so. They don’t tend to make a habit of explicitly telling the market they have too much or too little priced in, so the dropping of that reference can probably just be seen as a return to more normal communication from them.

Little emphasis on recent lower than expected inflation: Although inflation surprised on the downside a bit earlier this week, somewhat reminiscent of the Federal Reserve (Fed) comments last night, the minutes break non-energy Consumer Price Index (CPI) down into three parts:

1) core goods inflation which was expected to fall further on easing supply chain bottlenecks and “some cost pressures softening”; 2) Food/non-alcoholic beverage inflation which “was expected to rise further” and 3) Core services inflation which “had risen to 6.3% in October and to 6.4% in November” where “Contacts of the Bank’s Agents reported that consumer services prices continue to be pushed up by higher input prices, particularly pay, food and energy.” On pay, they point to risks on either side of their expectation that private sector wage growth would flatten off in coming months before declining later in 2023.

They aren’t sounding that downbeat on the outlook for the real economy in the near term. Bank staff have revised up their near-term Gross Domestic Product (GDP) forecasts (though expect a small fall in output) and they note that Intelligence from the Bank’s Agents was consistent with “only a modest further weakening in activity in the fourth quarter, centred in consumer-facing sectors”. As for early next year, “Taken together, the forward-looking survey evidence was broadly consistent with the projection in the November Report of a slight fall in GDP in 2023 Q1”.

Does it make sense to expect any more hikes from them? Probably, yes. The BoE are not as transparent as the Fed and European Central Bank (ECB) (and many other central banks) at signalling their near-term interest rate intentions, but:

1. They (sort of) signal that is what they are likely to do, albeit with important caveats and cautious use of language: “further increases in Bank Rate might be required for a sustainable return of inflation to target”. The paragraph in the minutes following that statement refers only to the risk of them needing to tighten policy “forcefully”: “There were considerable uncertainties around the outlook. The Committee continued to judge that, if the outlook suggested more persistent inflationary pressures, it would respond forcefully, as necessary.”
2. In November, they described the risk around their inflation projections as skewed to the upside. For those voting to hike rates, that sounds like it remains the case; in the paragraph describing the views of those who voted to hike 50bps “The labour market remained tight and there had been evidence of inflationary pressures in domestic prices and wages that could indicate greater persistence and thus justified a further forceful monetary policy response. Both services price inflation and private sector regular wage growth had increased significantly over the second half of the year, with the latter continuing to surprise on the upside since the November Report. There remained a risk that, following a protracted period of high inflation, inflation expectations could be slow to adjust downwards to target-consistent levels once external cost pressures had passed.” Recall that in November, 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.
3. When describing what monetary policy is trying to do, the minutes again include the line that “Monetary policy was also acting to ensure that longer-term inflation expectations are anchored at the 2% target.” According to the minutes, “Most measures of households’ and businesses’ inflation expectations had fallen back, but had remained at elevated levels”.

However, their next meeting in February is when they will take stock of the supply picture for the economy, where a key uncertainty for the forecasts (and therefore policy outlook) is how the supply-demand imbalance in the labour market will evolve. At the moment they think the labour market is “historically very tight but appeared to be past its peak tightness”. However, a deep dive into the supply-side could presumably change their views on the likely path for rates somewhat (in addition to regular news flow between now and then).

Fiscal changes don’t impact their forecasts much overall: This was the first meeting where they’ve had chance to react to the government’s Autumn Statement and they judged that although the fiscal policy changes would boost GDP on a one-year horizon, they would lower it to a similar degree in three years’ time. “The overall impact on the CPI inflation projection at all of these horizons was estimated to be small”. However, this overall verdict isn’t a complete surprise. They’d made clear in November that backloaded fiscal tightening wasn’t going to impact their forecasts much.

Overall, the minutes today and their last set of forecasts from November remain consistent with downside risk to my forecast peak for UK interest rates at 4.50%. However, I’m inclined to keep pencilling it in as the peak while domestically driven inflation pressures still look relatively strong.

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