BOE: The Crossover

Published on August 3, 2022
SGH Insight
Now Bailey, concerned about so-called second round effects feeding into inflation, looks set to cross over to recommend 50bp, and with the support of at least his chief economist Huw Pill, that vote should carry the day. Both supported only 25bp in June.
MPC members are fretting that price and wage setting behavior could entrench inflation at a higher level. In the most recent comments by a BOE official on July 7, Pill noted that the BOE’s guidance reflects “a willingness – should circumstances require – to adopt a faster pace of tightening than we have seen implemented in this interest rate cycle so far.”
Three of the four external board members – Jonathan Haskel, Michael Saunders, and Catherine Mann – already wanted 50bp in June. Of the four remaining votes, at least one, if not two other members, might also vote for 50bp.
Even as the Bank most likely opts for the bigger increment tomorrow, it will be careful not to suggest a string of 50bp moves will follow, nor even that it won’t sit out moves later this year. Additional guidance Thursday will, however, shape expectations about how quickly the Bank intends to get to a neutral rate around 2.25%.
Market Validation
Bloomberg 8/4/22

The pound reversed gains against the US dollar and UK bonds rallied after the Bank of England warned of a long recession and said its monetary policy path was not pre-set.
That took the shine off a widely expected 50 basis-point interest-rate hike for pound investors. The currency fell as much as 0.5% to $1.2084, having gained by that much before policy makers raised interest rates to 1.75%. Ten-year gilt yields dropped as much as eight basis points and part of the yield curve briefly inverted to reflect fears of an economic slowdown.
While delivering its biggest rate rise in nearly 30 years, the BOE suggested it could be less forceful in raising rates in the coming months. It warned the UK is heading for more than a year of recession under the weight of soaring inflation, leading traders to pile into gilts as a haven.

The Bank of England (BOE) is mulling its largest rate increase in more than 25 years, which would take the bank rate to 1.75% and see Governor Andrew Bailey, for the first time this cycle, join his peers in advocating a 50bp move (see SGH 7/11/22, “BOE: Minority Uprising”).

The BOE has increased its benchmark rate at five straight meetings to try to get inflation under control, including at its June meeting when it notched up its hawkish rhetoric on concerns about more persistent inflationary pressures and vowed, if necessary, to act forcefully in response. The June UK inflation rate was 9.4% year-over-year.

Bailey has presided over split votes in each of those meetings since the Monetary Policy Committee (MPC) began hiking with a 15bp move in December of last year. He managed to rein in the size of the moves in those meetings, proposing only 25bp increments despite a repeated push by at least three members who have wanted a bigger move. June’s vote for a 25bp hike to 1.25% was a 6-3 split. 

Now Bailey, concerned about so-called second round effects feeding into inflation, looks set to cross over to recommend 50bp, and with the support of at least his chief economist Huw Pill, that vote should carry the day. Both supported only 25bp in June. 

MPC members are fretting that price and wage setting behavior could entrench inflation at a higher level. In the most recent comments by a BOE official on July 7, Pill noted that the BOE’s guidance reflects “a willingness – should circumstances require – to adopt a faster pace of tightening than we have seen implemented in this interest rate cycle so far.”

Three of the four external board members – Jonathan Haskel, Michael Saunders, and Catherine Mann – already wanted 50bp in June. Of the four remaining votes, at least one, if not two other members, might also vote for 50bp.

Even as the Bank most likely opts for the bigger increment tomorrow, it will be careful not to suggest a string of 50bp moves will follow, nor even that it won’t sit out moves later this year. Additional guidance Thursday will, however, shape expectations about how quickly the Bank intends to get to a neutral rate around 2.25%.

Expectations of a subsequent 50bp move also could be tempered by more detail from the Bank about its plans to begin divesting its balance sheet. The BOE has denoted the bank rate as its primary tool for tightening policy. It has also been careful to reassure markets that sales would only commence when market conditions are stable and proceed in a gradual and predictable manner “so as not to disrupt the functioning of financial markets.”

After consultations with UK Debt Management Office peers, Bank staff has devised a strategy for the sales which this week will lay the ground for a confirmation vote by the Monetary Policy Committee at its September 15 meeting, with active sales to follow in October. 

The Bank has said it plans to sell between 50 billion and 100 billion pounds from its 875-billion-pound balance sheet, covering both sales and redemptions, in the first year of sales. In February, it stopped reinvesting the proceeds of maturing assets and some of its holdings have rolled off.

For the remaining outright sales, the BOE wants quantitative tightening to run “in the background” as it continues to push up its benchmark rate to try to curb runaway inflation as the economy slows. 

The Bank’s efforts are also coming amid a messy political leadership battle for the Prime Ministership which complicates the BOE’s task to calibrate its forward policy projections until it sees the economic impacts of any new tax and spending legislation. 

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