UK reaction: BoE leaves policy on hold, but sends signal to prepare for May hike

David Page, Senior Economist at AXA Investment Managers (AXA IM) comments on the latest Bank of England (BoE) meeting today.

  • The BoE left policy unchanged at today’s meeting, but two members voted for an immediate 0.25% hike.
  • Minutes from today’s meeting appeared to make the case for a move in May, consistent with February’s judgement that policy tightening was likely “somewhat sooner”.
  • We shift our forecast for the next 0.25% Bank Rate hike to May (from August).
  • We also now expect a follow up November hike to 1.00%.  

The Bank of England’s Monetary Policy Committee (MPC) left policy unchanged at today’s meeting. Bank Rate remains at 0.50%, the Asset Purchase Facility at £435bn and the corporate bond purchases at £10bn. This was in line with expectations. However, the decision to leave rates unchanged was not unanimous with Michael Saunders and Ian McCafferty both voting for an immediate 0.25% increase in Bank Rate. With today’s decision widely anticipated, more focus was on the minutes of today’s meeting to see what clues they offered about the prospect of future tightening.

Minutes to March’s MPC meeting have led us to change our rate forecast to expect two hikes this year, the first at the next meeting in May, from one hike in August. We concur with the MPC’s economic outlook. We expect GDP growth of 1.7% this year and 1.8% next (ahead of the 1.5% consensus). We believe this is faster than UK potential GDP growth, that it would drive labour market slack lower and generate domestic inflationary pressure. We forecast five hikes over the coming three years, broadly consistent with the BoE’s February projections which were conditioned on three hikes over the coming three years and left a modest overshoot of the inflation target at the two-year horizon (equivalent to a further hike). Our issue had only been on how quickly the BoE might tighten policy, assuming a cautious approach and waiting for confirmation of the expectation of rising wage growth in the January to April wage round. February’s message that rates might rise “somewhat sooner” suggested the BoE may proceed more quickly, something that we believe is confirmed in March’s minutes.

March’s minutes set the scene early on stating that the market-implied probability of a 0.25% Bank Rate hike in May “had increased to around 90%”. The minutes did nothing to push back against such an expectation. They stated

  • “Recent data releases are broadly consistent with the MPC’s view … as set out in the February Inflation Report”.
  • Described the world economy as “remained strong” with “accommodative financial conditions”, without mentioning more recent trends of softening global indices.
  • Dismissed downward revisions to Q4 UK GDP growth and composition as “prone to significant revision” and to the Q1 outlook as “likely to be temporary”.
  • Described wage growth as having “increased steadily, as expected”, whereas the annualised measure the BoE had previously referred to had slowed back in line with the latest 3-year average.     
  • Our interpretation of these minutes was that they built a case for a hike in May. They have convinced us that February’s “somewhat sooner” is likely to refer to a hike at the next meeting.

Such an interpretation was helped by two Committee members voting for an immediate tightening in policy. We (and the rest of the MPC) see no such urgency, but the broader MPC reminded that “the May forecast round would enable the Committee to undertake a fuller assessment”.

Over the longer-term, the BoE referenced a Reuters survey showing a modal Bank Rate forecast of 1.25% by end-2019. Given the apparent eagerness of the MPC to continue to withdraw stimulus, we modestly fine-tune our outlook, shifting from expecting one hike in 2018 and two in both 2019 and 2020 to two in 2018 and 2019 and just one in 2020. This would see Bank Rate at 1.50% by end-2019. We consider this consistent with the Committee’s assessment that “an ongoing tightening of monetary policy over the forecast period .. at a gradual pace .. ”. This outlook is, similar to the BoE’s, based on a smooth passage to Brexit and the recently agreed transition phase. This is far from guaranteed we are mindful of the risks of a material derailment of this process that would push back rate hike expectations.

Financial markets which had broadly priced in a May hike saw some strengthening. 2-year and 10-year yields fell by 2bps and 4bps to 0.91% and 1.46% respectively. Sterling declined against both the euro (-0.2%) and the US dollar (-0.3%) and the FTSE was also 0.4% lower on the announcement. Nevertheless, expectations firmed for a May hike and the probability for a second hike in November was above 50%.   


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