UK Reaction: One More Hike
• The Monetary Policy Committee (MPC) hiked Bank Rate by 25 basis points (bp) to 4.25% in line with our own and market expectations.
• The MPC judged that the risk of persistence remained high as the labour market remains tight and is set to remain tight over coming months, and at the same time the growth outlook has improved.
• Discussion of the impact of the recent turmoil in the banking sector was notably brief. The Bank of England’s Financial Policy Committee judges that domestically, the UK banking system remains resilient. However, risks remain from this channel, particularly if concerns in overseas banks grows.
• The MPC remains wary of inflation persistence and intelligence from BoE agents points to the labour market remaining tight in coming months, which suggests the appetite for tighter policy will remain. May’s meeting also comes alongside a full forecast update, which look likely to be firmer than in February, adding to risks of additional tightening.
• We raise our expectation for Bank Rate, adding a further 25bp hike to 4.50% at the next meeting in May. We consider this a close call and see data released between now and the May meeting, as well as further evidence of the impact of broader banking concerns as central to this decision.
The BoE's MPC raised Bank Rate by 0.25% to 4.25% in line with our own and market expectations. The MPC judged that the risk of persistence remained high as the labour market remains tight and is set to remain tight over coming months, and at the same time growth has remained resilient. The decision to increase rates by 25 basis points (bp) was supported by seven members of the MPC, with Silvana Tenreyro and Swati Dhingra voting to keep rates on hold. The dissenting voters argued that lags in the transmission of monetary policy mean the full impact of tightening is yet to be felt and that further hikes would accelerate the point at which rate hikes would need to be reversed.
The minutes of today’s meeting set out how the economic outlook had evolved since the last meeting in February. Growth had been stronger than expected: the BoE continues to expect GDP to decline this quarter, but now expects growth to increase slightly in Q2 – compared to an expected 0.4% contraction – with the government’s extension of the Energy Price Guarantee at £2500 helping to prevent sharper declines in household income. The labour market is expected to remain resilient: employment growth is forecast to remain solid until mid-2023 and unemployment is now expected to “remain around its current low level rather than starting to rise". At the same time, the MPC also now expects wage growth to moderate considerably over the coming months. Provisional BoE estimates also see additional fiscal support announced in the Spring Budget boosting GDP by 0.3% over the coming years, contributing to further upside in the growth outlook.
Discussion of the impact of the recent turmoil in the banking sector was notably brief. The MPC acknowledged that “uncertainties around the financial and economic outlook have risen". The BoE’s Financial Policy Committee judges that domestically, the UK banking system remains resilient and is well placed to weather the risks posed by raising rates and other potential stresses. Whilst the UK banking system is in good shape, the increase in wholesale funding costs should have only a minor impact on credit conditions. However, risks remain from this channel, particularly if concerns in overseas banks grows.
The Bank’s assessment of inflation persistence revolves around three key factors: the tightness of labour market conditions, the behaviour of wage growth and services inflation. Evidence from the broader labour market remains tight and questions any cooling, but rather suggests stabilising around current levels. Wage growth in contrast has begun to moderate and services inflation was broadly in line with BoE expectations (-0.1ppt). In our view, wage growth, which reflects the balance of supply and demand in the labour market and is the central driver of domestically-generated medium-term inflation, should supersede broader measures of labour market tightness. However, the MPC appears to place weight on these broader metrics, which in turn suggests appetite for tighter policy. May’s meeting also comes alongside an updated Monetary Policy Report which will provide updated forecasts, which in turn looks likely to be firmer than in February, adding to risks of additional tightening.
We raise our expectation for Bank Rate, adding a further 0.25% increase to 4.50% at the next meeting. We consider this a close call and see data released between now and the May meeting, as well as further evidence of the impact of broader banking concerns as central to this decision. We continue to expect the BoE to begin unwind rate hikes this year. We forecast a first 25bp cut in Q4 this year. We then forecast Bank Rate falling back to end-2024 at 3.25%. Indeed, an additional hike in May adds conviction to our call that the Bank will begin unwinding hikes sooner as the economy slows and labour market adjustment accelerates.
Markets had fully priced a 25bp hike by the BoE and rate markets were little changed following the announcement. The pound moved considerably following the hike – sterling appreciated 0.2% against the dollar and is now trading around $1.23. It also made gains against the euro following the announcement but has since retraced most of those gains since settling around £0.88.