BOE: Tweaks For Twin Risks

Published on June 15, 2022
SGH Insight
Weaker UK growth and wages data all but lock in another 25bp hike by the Bank of England tomorrow as it races to get spiraling inflation under control to avoid it ravaging household spending power and plunging the UK economy into recession.
This week’s data will likely constrain the Bank’s policy choice for this meeting to a 25bp hike despite the possibility for additional dissents for a larger move by the Bank’s Monetary Policy Committee (MPC) members. At its early May meeting when the MPC raised rated 25bp to 1%, Michael Saunders, Catherine Mann, and Jonathan Haskel dissented in favor of 50bp.
This time around, that continued pressure may however force the MPC to amend its forward guidance so that it at least widens its options for additional moves later this year.
In May the Bank said, “most members of the Committee judge that some degree of further tightening in monetary policy may still be appropriate in coming months,” but it noted “risks on both sides of that judgement.”
The Bank may seek to harden that guidance as it continues to navigate what it calls a narrow path between the twin risks of upside prices and the intensifying squeeze on real household incomes that is coming from higher energy and goods prices. That dichotomy is splintering consensus as members are increasingly forced to choose between hitting their inflation target within their forecast horizon and avoiding a more pronounced recession.
Market Validation
Bloomberg

The Bank of England hiked interest rates for
a fifth straight meeting and sent its strongest signal yet that
it is prepared to unleash larger moves if needed to tame
inflation.
The nine-member Monetary Policy Committee voted 6-3 to
increase rates by 25 basis points to 1.25%, with a minority of
officials maintaining their push for a move double that size.
Still, the BOE hinted that it may join a growing global
trend for larger hikes if inflation continues to soar, saying
“it would be particularly alert to indications of more
persistent inflationary pressures, and would if necessary act
forcefully in response.”
Crucially, that language was endorsed by all the BOE’s
voters, a departure from May when two declined to sign up to
guidance that more hikes were needed.

Weaker UK growth and wages data all but lock in another 25bp hike by the Bank of England tomorrow as it races to get spiraling inflation under control to avoid it ravaging household spending power and plunging the UK economy into recession.

This week’s data will likely constrain the Bank’s policy choice for this meeting to a 25bp hike despite the possibility for additional dissents for a larger move by the Bank’s Monetary Policy Committee (MPC) members. At its early May meeting when the MPC raised rated 25bp to 1%, Michael Saunders, Catherine Mann, and Jonathan Haskel dissented in favor of 50bp.

This time around, that continued pressure may however force the MPC to amend its forward guidance so that it at least widens its options for additional moves later this year.

In May the Bank said, “most members of the Committee judge that some degree of further tightening in monetary policy may still be appropriate in coming months,” but it noted “risks on both sides of that judgement.”

The Bank may seek to harden that guidance as it continues to navigate what it calls a narrow path between the twin risks of upside prices and the intensifying squeeze on real household incomes that is coming from higher energy and goods prices. That dichotomy is splintering consensus as members are increasingly forced to choose between hitting their inflation target within their forecast horizon and avoiding a more pronounced recession.

The BOE’s May projections were conditioned on a market-implied path for the bank rate that rises to 2.5% by mid-2023. Bank officials are believed to be eying a neutral rate of 2.25% before members decide whether to push into restrictive territory. Thursday’s move, a fifth successive hike, would put the Bank rate at 1.25%.

CPI inflation hit a 40-year high of 9% in April ahead of an expected peak at least at 10% when energy bills are due to surge in October. But despite the three dissents for a bigger move in May, the committee’s majority have remained fearful that aggressive tightening could trigger a more severe recession than the slowdown the Bank is projecting. 

In May the Bank also predicted GDP growth would slip to 1.0% this year and to zero in 2023 from a prior forecast of 1.2%. The Office for National Statistics (ONS) reported Monday a surprise contraction in GDP growth of 0.3% in April, compared to positive growth of 0.1% predicted by economists.

Meanwhile, employment data for April showed UK pocketbooks deteriorated the most in more than two decades as surging prices swallowed up wage increases.

The ONS also reported that employment rose 177,000 in the three months to April, even as real wages (before bonuses) slumped a whopping 4.5% in April versus the same month a year ago. The unemployment rate ticked up to 3.8% from 3.7%.

While we expect the BOE to reiterate plans for more hikes this year, May’s somewhat hedged guidance was predicated on the Bank’s view that price pressures were largely externally driven and would eventually dissipate.

Since May, the UK government announced fiscal support including a 15 billion stg “cost of living” support package that may help improve the BOE’s growth expectations by the time of the August 4 Monetary Policy Report forecasts update.

In addition, a more aggressive pace of tightening anticipated in the US by the Federal Reserve, which is putting downward pressure on sterling, could alter the BOE’s schedule for inflation to return to the 2% target before 2025.

Though the BOE has indicated its August 4 meeting would largely be devoted to describing a schedule and plans for outright sales of its bond portfolio, it may therefore end up choosing not to skip a rate hike at that meeting if its inflation objectives are further threatened.

The BOE has said inflation will persistently overshoot the 2% target if rates remain at the current 1% rate but would fall short of the 2% goal if benchmark rates reach 2.5%. That puts a neutral sweet spot for the bank rate somewhere around 2.25%.

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