Bank of England hikes 50bp with a dovish message (which doesn't mean they won't hike again)

As expected, the Bank of England’s (BoE) Monetary Policy Committee (MPC) hiked rates 50bp (same as in December 2022), with domestic inflationary pressure stronger than they’d expected. Bank rate is now 4.00%. The vote wasn’t unanimous, but dissent was in a dovish direction (Tenreyro and Dhingra again wanted rates unchanged).

It sounds like they think this might be the peak for rates, but with enough emphasis on upside risks to inflation to support more hawkish views too.

The forward signalling has changed again. This time, importantly, they drop the reference to “future increases in Bank Rate may be required”.

Previously:
“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.”

Now:
“If there were to be evidence of more persistent pressures, then further tightening in monetary policy would be required.”

In other words, there is no presumption that there will be further rate increases. They also no longer refer to potential ‘forceful’ rate hikes (previously: “The Committee continued to judge that, if the outlook suggested more persistent inflationary pressures, it would respond forcefully, as necessary” [author’s italics]).

Governor Bailey referred directly to this change in message in the press conference – he emphasised it and said it was deliberate… but he also played it down somewhat, as did Deputy Governor Broadbent. Bailey referred to turning a corner on inflation, but also said that the risks are very large and it is early days. He said that if they continue to get overshoots in wage data and services inflation then “we will have to respond to that”.

Broadbent, meanwhile, said that “we stress that more persistent case” (talking about the risk of more persistent domestic inflation) and “risks are to the upside”. He said that it wasn’t obvious we’ve got to a peak “or that the next move is equally likely in one direction or another”.

Why they might pause: Alongside the change in signalling above, their inflation forecasts are based on a profile for interest rates which has rates peaking at about 4.5% (a touch below) then being cut by a percentage point or so over the following two years. Using those assumptions, they have Consumer Price Index (CPI) inflation well below target in two years’ time (0.95%Y). i.e. at face value they are telling us that the market still has too much priced in for rates. In the version of their forecasts based on constant interest rates from here, they also have inflation well below target in two years’ time.

So aren’t the BoE on hold now and on the brink of a pivot? I’m not convinced:

1. The outlook is very uncertain – a fact heavily emphasised including by Bailey and others. Domestic inflationary pressure still looks strong. With recent BoE communication, it is important not just to look at their central case forecast, but also how they see the risks around it. 
2. Ramsden played down the importance of the forecasts in their decision making, saying that given the uncertainties, he probably had more confidence with the immediate period ahead rather than two or three years out. He said that “we are using the forecast, but having to use it in a more nuanced way now.” That reflects there being more “moving parts” now where the supply side of the economy – potential supply growth – is no longer “pretty steady” in the way it was before the Global Financial Crisis.
3. This time they’ve actually raised their forecasts for the real economy. They have become less pessimistic on the economy with less negative GDP growth rates… Their forecasts for GDP and unemployment now look much closer to consensus over the next two years than before (rather than being a lot more pessimistic). That their CPI forecasts aren’t higher reflects (changeable) gas prices and the exchange rate: “CPI inflation is expected to be broadly similar in the medium term to the equivalent November Report projection. This reflects the impact of the more downward sloping path of wholesale gas futures prices and the appreciation of the sterling exchange rate, which is offset by a somewhat less negative path of the output gap.”
4. Most important is that upside skew of risk to their forecasts. At the moment, “risks around the central projection are judged to be skewed significantly to the upside” [author's italics]. They said that “There remain a number of significant risks to the outlook for CPI inflation from more persistent strength in domestic wage and price setting”. All of this, they say, pushes up on the mean inflation projection (as opposed to the mode which is what gets shown as their ‘central’ projection). Bailey in his opening statement said that the forecast risk is skewed more to the upside than at any point in their history.
5. They say that “it is difficult to quantify precisely the nature of the upside risks to inflation from greater persistence in domestic inflationary pressures, but qualitatively, an inflation forecast that takes into account these upside risks is judged to be much closer to the 2% target at the policy horizon than the modal central projection.” [author’s italics]. Their mean forecast, including that ‘market’ assumption of a bit more hiking from here, has CPI inflation at 1.75% in Q1 2025 and 2.22% the quarter before that (i.e. no longer well below the target in two years’ time, even if it does fall further three years ahead).

That said, they might pause here for a while.

1. Those who voted for a hike sound like they think they’ve addressed the risk of stickier domestic inflation pressure: In the section of the minutes where they describe the views of the majority, they say “A 0.5 percentage point increase in Bank Rate at this meeting would address the risk that domestic wage and price pressures remained elevated even as external cost pressures waned”.
2. Their forecasts for CPI now have the headline rate at 3.9% in Q4 2022, but 4.3%Y for the mode. That is above my central forecast. In other words, the bar for upside inflation surprises at headline level looks significant. However, they have said they will be watching wage and services inflation.

Overall, I continue to see downside risk to my forecast peak for UK interest rates at 4.5%. It seems very plausible that they will now pause for at least a meeting or two. However, I’m inclined to keep pencilling in another 50bp of hikes while domestically driven inflation pressures still look relatively strong. As a reminder, private sector pay growth came in at 7.2% in the last set of UK labour market data…

This is a financial promotion and is not investment advice. The views expressed are those of the author at the date of publication unless otherwise indicated, which are subject to change, and is not investment advice.