Bank of England: Original Thinking

Published on March 4, 2022
SGH Insight
Fueled by fears that inflation expectations are out of hand and that second-round effects will create a bigger policy headache down the road, the Bank of England is not wavering from its campaign to frontload a series of hikes to help guide interest rates toward neutral and bring inflation under control.

The Monetary Policy Committee is set to hike 25bps at each of its next two meetings at least, adding to its two recent consecutive moves that took the benchmark rate to 0.50%. Hikes at the upcoming March 17 and May 5 meetings will take the benchmark rate to 1.00%. A June move is likely, but less certain.
Market Validation
Bloomberg 3/18/22

Pound Trims Gains as Bank of England Highlights Symmetric Risks

The pound faded an earlier gain against the dollar after the Bank of England delivered an expected 25 basis point hike, but warned of symmetric risks. “Based on its current assessment of the economic situation, the Committee judges that some further modest tightening in monetary policy may be appropriate in the coming months, but there are risks on bothsides of that judgement,” the statement read.

Here are the key headlines:

*BANK OF ENGLAND RAISES BENCHMARK INTEREST RATE TO 0.750%
*BOE: INFLATION ‘AROUND 8%’ IN 2Q, MAY CLIMB HIGHER LATER
*BOE VOTES 8-1 TO RAISE RATES, WITH CUNLIFFE BACKING NO CHANGE


Fueled by fears that inflation expectations are out of hand and that second-round effects will create a bigger policy headache down the road, the Bank of England is not wavering from its campaign to frontload a series of hikes to help guide interest rates toward neutral and bring inflation under control.

The Monetary Policy Committee is set to hike 25bps at each of its next two meetings at least, adding to its two recent consecutive moves that took the benchmark rate to 0.50%. Hikes at the upcoming March 17 and May 5 meetings will take the benchmark rate to 1.00%. A June move is likely, but less certain.

Markets have pared bets that rates will peak at more than 2.25%, and from the Bank’s perspective, this week’s retreat in market pricing for the cycle in response to Russia’s advance on Ukraine appears to have brought pricing better in line with the Bank’s original outlook. 

Most MPC members have seemed leery of validating those higher market expectations, with the Bank staff still wanting to see evidence of inflation abating a little, which they believe will occur in the second half of the year.

Far from shying from the inflation fight however, Governor Andrew Bailey flagged last week a common concern among MPC members that inflation would likely overshoot the bank’s own forecasts, a point reiterated by fellow committee member Michael Saunders. 

This week Saunders, the most hawkish MPC member, said that the Bank’s projections which are underpinned by a 1.5% market implied path for the bank rate, were already likely obsolete. The BOE has forecast inflation to peak at a 30-year high of around 7.25% in April, when a massive 54% hike in regulated household energy bills takes effect. 

Saunders, who along with three other members dissented in favor of a 50bps increase last month, wants “to move quite quickly towards a more neutral stance.” He is not advocating another 50bps in March but he wants “prompt tightening now,” which most members agree will negate the need for a lengthier cycle.

For now that translates to a series of two or three more consecutive hikes. 

Fellow MPC member Catherine Mann, speaking to an event in the US, said expectations that wages will rise about 5% this year are a sign of “embedded” inflation in the UK and that second-round effects will lift consumer prices. 

The dual impact of higher wages and price setting is flashing red to the Bank, especially as businesses warn of the ease with which they are passing higher costs onto consumers. The latest Lloyds Bank Business Barometer showed half of 1,200 firms polled expect to raise prices in the coming year to cover escalating wage bills and other expenses.

Bailey is worried about this being passed through to households. “There is very clearly upside risk ….from second round effects.” 

Prior to his comments, the Bank moved to a more aggressive rates posture at its February meeting which markets priced as a greater number of hikes than the BOE seems to have had in mind. 

The Bank’s strategy clearly is to front load “modest tightening” before guiding the benchmark rate back to neutral, and with it inflation back down to the 2% target over the medium term.

There are risks to that approach. MPC members harbor no illusions that policy can check near term actual inflation with rate hikes. They also need data evidence their predicted inflation peak comes to pass. In the meantime they are just as worried about the threat of untethered inflation expectations.

Consensus appears to be coalescing around delivering potentially three more hikes in consecutive order, after which policy should be on a better footing to contend with any residual upside inflation risks.

That strategy is even more fortuitous as the BOE looks to manage the already significant and visible inflation risks while it assesses the highly uncertain growth and inflation impact on the UK and global economy from Russia’s invasion of Ukraine.

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