04.11.2022
The Monetary Policy Committee (MPC) hiked the Bank Rate by 75 basis points (bps) to 3.00% - the first 75 bps hike by the Bank of England (BoE) in 33 years, but in line with ours and market expectations.- The MPC voted 7-2 in favour of the hike, with both dissenters looking for smaller hikes.
- The Committee firmly pushed back against recent market pricing of the Bank Rate, which in the MPR was characterised as peaking at 5.2%.
- The BoE's economic projections envisage recession - prolonged assuming high market rates - and inflation falling sharply.
- We continue to expect the MPC to hike rates, but at a slowing pace. We pencil in a 50 bps hike in December and February and a further 25 bps hike in March.
- Yet as the labour market turns we see the MPC's skew to inflation risks fading, opening the prospect for rate cuts before year-end.
The BoE's MPC raised the Bank Rate by 0.75% to 3.00% in line with our own and market expectations. The MPC's first 75 bps hike in 33 years was delivered alongside updated economic projections in its November Monetary Policy Report (MPR), which forecasts inflation to fall well below their 2% target based on an assumption of future rates moving in line with market expectations.
The MPC voted 7-2 in favour of the hike, with Swati Dhingra and Silvana Tenreyro preferring smaller 50 bps and 25 bps moves respectively. The majority viewed the greater move as warranted given the continued tightness of the labour market and upside risks to demand provided by recent government policy to cap energy prices and a significant skew to perceived risks around the inflation profile. In addition, today's decision likely had an eye to limiting downsides to sterling and the potential of greater imported inflation, following the recent 75 bps moves by the European Central Bank (ECB) and Federal Reserve (Fed). Dissenters, Dhingra and Tenreyo argued for more gradual tightening given weakness in economic activity and the fact that much of the recent tightening had yet to fully impact the real economy given the lagged transmission of monetary policy.
The MPC firmly pushed back against recent market pricing of the Bank Rate, which, in the MPR, was characterised as peaking at 5.2%. Further reinforcing this, Andrew Bailey stated in the press conference that whilst the Bank Rate may have to rise further, it was unlikely to reach levels expected by markets. Indeed, on market rates BoE projections see inflation well below target and falling - consumer price index (CPI) inflation is forecast at 1.5% at the end of 2024, falling further to 0% at the end of 2025. The BoE also forecasts growth declining sharply over the coming years with the energy shock facing consumers exacerbated by a considerable tightening in financial conditions; on market rates they expect GDP growth to average 4.25% this year, -1.5% next year and -1% in 2024. Market pricing of rates has changed since the Bank's forecast was produced and prior to the announcement markets saw rates peaking at 4.70% and following it have eased by a further 5 bps to 4.65%. The outlook is less severe on the Bank's constant rates assumption, but still remains bleak. The BoE sees growth declining by -1% next year and -0.25% in 2024 on constant rates, it also sees inflation just above target at 2.6% at the end of 2024 and ending the forecast horizon at 1.2%.
The path of future fiscal policy remains uncertain ahead of the 17 November Autumn statement and is likely to have a material impact on the inflation outlook. In their modelling, the Bank assumed that some fiscal support remains in place beyond the six-month period of the current Energy Price Guarantee Scheme, with the BoE assuming a "stylised forecast" halfway between the full cap of the coming six-months and a reversion to the Office of Gas and Electricity Markets pricing cap. As usual, the BoE included no assumption of future policy changes that may be announced on 17 November, but noted that any future fiscal tightening would be relevant particularly whether this tightening fell during or after the BoE's relevant time horizon.
The MPC signalled that more rate hikes are likely, and we expect the continued strength of the labour market to see the Bank remain cautious to ensure inflation expectations remain anchored, albeit expecting the Bank to continue hiking at a reduced pace. We expect the BoE to hike rates by 50 bps in December and February and a further 25 bps in March bringing rates to 4.25%. The precise path will be highly dependent on the evolution of the labour market. We currently expect the slowing in economic activity to see a turn in the labour market. As this materialises, much of the perceived upside skew to the BoE's inflation forecasts will fade. This will then likely see the Bank place more weight on its longer-term forecasts - at present more in keeping with rates staying around 3% than the 5.25% market rate profile. This should eventually open the prospect of some unwind in the BoE's tightening, something that we now consider likely before end-2023.
Rate market reaction to the hike was muted given the 0.75% increase was almost fully priced and BoE reticence over market pricing well known. 2-year gilt yields are currently down 2 bps relative to their pre-meeting level at 3.00% and 10-year yields were unchanged at 3.48%. There was a greater reaction in sterling. Dollar gains in the wake of yesterday's Fed meeting had seen cable under pressure, but it has fallen a further 0.4% versus the US dollar to $1.12. Sterling fell by a sharper 0.8% against the euro to £0.872.
