Bank of England: Slower for Longer

Published on April 26, 2022
SGH Insight
The Bank of England is set to deliver its fourth successive rate increase on May 5 as it struggles to contain inflation exacerbated by the pandemic and Ukraine invasion, whose twin price shocks are also weighing on domestic activity.
A June move still remains more likely than not, albeit less certain as we have written, and the window for the BOE’s campaign to modestly “front load” hikes is beginning to close. The Bank does not meet in July and will resume from August 4.
Some policy committee members, absent sagging activity, would prefer to move again in June, probably by bigger increments and opt to keep moving until the key bank rate ranges somewhere around a consensus estimate of neutral.
As domestic budgets become increasingly constrained, the Bank will have to face off the political blowback from its next couple of moves, before stepping to the sidelines to let households catch their breath.
The BOE is on the precipice of what we have described as a “second phase” of tightening, characterized by less frequent moves over a longer time horizon, with data dictating meeting-to-meeting outcomes.
Market Validation
Dow Jones 5/5/22

BOE Raises Rates for Fourth Time, But Signals Future Caution

The Bank of England raised its key interest rate for
the fourth time in as many meetings of its policy makers, but signaled that it
is likely to move cautiously in coming months as worries grow over a slide
into recession for the world's fifth-largest economy.


In a statement Thursday, the BOE raised its key rate to 1% from 0.75%. That
means the central bank has increased borrowing costs at four straight meetings
of its Monetary Policy Committee, a sequence unmatched since the late 1990s.

Six MPC members voted for the rate rise to 1%, while Jonathan Haskel,
Catherine L. Mann and Michael Saunders each voted for a larger rise to 1.25%.

The central bank also said it has asked its staff to prepare a plan for
selling some of the bonds it bought as part of its past stimulus programs.
That plan will be outlined in August, but bond sales would start later.

However, the central bank indicated that it is likely to raise rates more
slowly, if at all, in coming months, with the very high energy prices that
have followed Russia's invasion of Ukraine set to squeeze household spending
power and weaken economic growth.

In its statement, the BOE said further rises in its key rate "may still be
appropriate" in coming months, but added that two of its policy makers didn't
support that guidance and instead thought it likely the key rate would stay at
1%.

*POUND EXTENDS LOSSES, FALLS MORE THAN 2% AGAINST THE DOLLAR
*U.K. BONDS EXTEND SURGE, TWO-YEAR YIELDS FALL 20 BASIS POINTS

The Bank of England is set to deliver its fourth successive rate increase on May 5 as it struggles to contain inflation exacerbated by the pandemic and Ukraine invasion, whose twin price shocks are also weighing on domestic activity.

A June move still remains more likely than not, albeit less certain as we have written, and the window for the BOE’s campaign to modestly “front load” hikes is beginning to close. The Bank does not meet in July and will resume from August 4.

Some policy committee members, absent sagging activity, would prefer to move again in June, probably by bigger increments and opt to keep moving until the key bank rate ranges somewhere around a consensus estimate of neutral. 

As domestic budgets become increasingly constrained, the Bank will have to face off the political blowback from its next couple of moves, before stepping to the sidelines to let households catch their breath.

The BOE is on the precipice of what we have described as a “second phase” of tightening, characterized by less frequent moves over a longer time horizon, with data dictating meeting-to-meeting outcomes.

Part of that strategy is driven by a unanimous commitment to continue to lean against inflation psychology becoming embedded at a higher level.

UK inflation has risen to 7%, spurred by increasing prices for fuel, energy and food, effects exacerbated by the invasion of Ukraine. The Bank has already pushed out its expected inflation peak once, and now tips prices to climb further beyond 8% later this year.

To be fair, the BOE action so far this cycle shows it is seeking to try to guard against so-called second round effects that would slow activity further and increase unemployment. 

In contrast to most other major central banks, a vote to hike again next month will have delivered almost 100bps of tightening in four moves since rates were taken down to 0.1% to deal with the effects or the pandemic.

The monetary policy committee is not so much focused on the outright terminal level of the key benchmark rate, as it is on proceeding at a pace that over time, avoids tipping the economy into recession. 

While that may mean the Bank will likely deliver less in aggregate tightening this year than the market continues to price into the GILTS curve, it does not mean the BOE is near the end of its cycle necessarily; but only pausing to mark the data against its projections for inflation to peak later this year.

Though markets continue to price in an end point closer to 2.25% by year end, the BOE is more likely to stop shy of even 2% until it gains confidence in the projected inflation peak and households find relief.

In the meantime, and notwithstanding higher inflation, it sees accommodative monetary policy as still appropriate given downside risks to the economy. 

It also views the current bank rate as still below its own estimates of a neutral range between 1-2%.

The inflation targeting bank is being forced to tolerate prices surging to their highest level in 30 years as households bow under the increased burden of dwindling disposable income.

Meanwhile UK manufacturers are raising prices at their fastest clip in more than 40 years to cover soaring raw material and energy input costs, according to the Confederation of British Industry.

At its March meeting, the BOE delivered a “dovish hike,” raising rates to 0.75bp even as it eased back from February’s more hawkish forward guidance. It said further modest tightening “may” be appropriate in the coming months versus “was likely” to be appropriate,

Governor Andrew Bailey, on the sidelines of the 2022 Spring meetings of the International Monetary Fund and the World Bank, last week acknowledged future policy decisions are becoming more dicey.

Bailey said the negative output effects of the real income shock could risk UK recession if inflation is pushed down too far.

In another signal of the BOE’s sensitivity to the need to cushion the economy, the May meeting will likely signal it is not ready to sell assets from its balance sheet despite having previously indicated that 1% in the bank rate might trigger active selling.

BOE officials are continuing their consultations with the UK Debt Management Office about how to dispose of the 875 stg from the Bank’s balance sheet following February’s vote to cease reinvestments.

Bailey, a previously strident advocate of moving to reduce the balance sheet as quickly as possible following pandemic-inspired quantitative easing, last week cautioned that the BOE will not actively sell assets into “fragile markets,” nor amid worsening economic conditions.

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