PREVIEW: Bank of England - To Hike Or Not?

OVERVIEW

Since the prior meeting, markets have fully priced in a 15bps hike to the Bank Rate to 0.25%. Expectations for a move on rates have been stoked by comments from BoE Governor Bailey who cautioned that the MPC "will have to act" to contain inflation, whilst Chief Economist Pill noted that inflation in the UK is likely to hit 5%.

Surveyed economists have less conviction than markets when it comes to a move on rates with 47/59 asked by Reuters (Oct 13th-20th) looking for the rate to be held at 0.1%. The lack of pushback (except from Tenreyro and Mann) from MPC members on market pricing has led some desks to revise their calls for the upcoming meeting.

Therefore, if the MPC fails to move on rates this could cause some credibility issues for the Bank. If policymakers opt to raise the Bank Rate, the MPC may decide to push back on some of the aggressive pricing throughout 2022; pricing that would align with the MPC having to a) stop reinvesting maturing Gilts and then b) actively start selling Gilts into the market.

For the APF itself, the remit is expected to be held at GBP 895bln (GBP 875bln Gilts and GBP 20bln corporates). This decision is set to be subject to dissent from external member Saunders and Deputy Governor Ramsden given this is how they voted in September.

PRIOR MEETING

As expected, the MPC opted to maintain the Bank Rate at 0.1% and the APF at GBP 895bln. The decision on the latter was subject to dissent once again from external member Saunders with Deputy Governor Ramsden joining him in voting for a reduction in the Gilt remit to GBP 840bln from the current level of GBP 875bln. Saunders and Ramsden based their dissent on the basis that “continuing with asset purchases when CPI inflation was above 3% and the output gap was closed might cause medium-term inflation expectations to drift up further”.

On inflation, the policy statement noted that “CPI inflation is expected to rise further in the near term, to slightly above 4% in 2021 Q4” whilst acknowledging that advances in spot and forward wholesale gas prices since the August Report represented an upside risk to the MPC’s inflation projection from April 2022.

From a growth perspective, supply constraints on output prompted Bank staff to revise lower their expectations for the level of UK GDP in Q3 2021 by around 1% since the August Report.

Commentary was also cautious on the labour market with the statement noting increasing uncertainties presented by the end of the furlough scheme, the duration of changes to unemployment and difficulties in matching workers to available jobs. The statement saw the inclusion of a new line noting that “some developments during the intervening period appear to have strengthened that case, although considerable uncertainties remain”. Accordingly, money markets brought forward rate-hike pricing of 15bps to Mar'22 (vs May'22 prior to the announcement).

RECENT DATA

Y/Y CPI for September cooled a touch to 3.1% from 3.2% whilst the core metric ticked lower to 2.9% from 3.1%. Despite the climbdown in inflation for the month of September, the direction of travel is still expected to be an upwards one with ING pencilling a peak rate of 4% in April 2022. When it comes to inflation expectations, Citi/YouGov 12-month inflation expectations rose to 4.4% in October from 4.1% in September; the highest reading since 2008.

On the growth front, the August GDP print of 0.4% was an improvement on the 0.1% contraction seen in July, however, Q3 growth is on track to come in notably below the BoE's projection of 3%. More timely data from IHS Markit saw the Composite PMI reading for October rise to 56.8 from 54.9 with the report noting "The UK economy picked up speed again in October, but the expansion is looking increasingly dependent on the services sector, which in turn looks prone to a slowdown amid the recent rise in COVID-19 cases".

In the labour market, the unemployment rate in the three months to August fell to 4.5% from 4.6%, however, it is worth noting that the furlough scheme concluded at the end of September. Average weekly earnings (ex bonus) fell to 6.0% from 6.8% in the three months to August with the ONS (with a fair degree of uncertainty) forecasting an underlying ex-bonus earnings growth rate of between 4.1-5.6%.

RHETORIC

Governor Bailey (October 17th) led to a repricing of expectations for UK tightening with the policy chief noting that although monetary policy cannot solve supply-side problems, the Bank will have to act and must do so if “we see a risk, particularly to medium-term inflation and to medium-term inflation expectations”.

Chief Economist Pill warned that inflation was likely to rise close to or even slightly above 5% in early 2022, adding that the November meeting is "finely balanced", but he thinks it is a live meeting. Elsewhere, external member Saunders has warned “…markets have priced in over the last few months an earlier rise in Bank rate than previously and I think that’s appropriate”.

However, tempering expectations of imminent action at the more dovish end of the spectrum, external member Tenreyro remarked that raising interest rates to counter increasing prices in areas such as energy and semiconductors would be “self-defeating” if those rises prove to be one-offs. Furthermore, external member Mann has suggested that rate hikes “can wait”.

Elsewhere, Deputy Governor Broadbent, in a private meeting with bankers reportedly downplayed the prospect of an interest hike at the upcoming meeting. Deputy Governor Ramsden has not spoken since the prior meeting at which he voted to curtail the Bank's QE programme. Deputy Governor Cunliffe and external member Haskel have not spoken on monetary policy since the prior meeting. 

QE

The MPC is expected to maintain its APF at GBP 895bln (GBP 875bln Gilts and GBP 20bln corporates). The decision is set to be subject to dissent from external member Saunders and Deputy Governor Ramsden given this is how they voted in September. Despite the prospect of a rate hike at the Bank, desks are of the view that given purchases under the APF are set to conclude in December, halting them a month early would have little impact.

That said, given the recent acceleration in market pricing for rate hikes, it is worth noting that the MPC's forward guidance notes that when the Bank Rate reaches 0.5%, the Bank will halt reinvestments and then when it reaches 1% the Bank will actively start selling Gilts.

RATES

As it stands, markets currently fully price in a 15bps hike to 0.25% at the upcoming meeting with 27bps worth of tightening priced in by year-end and the rate seen rising to 1.0% by Jun'22. In contrast to this pricing, economists generally expect no change to the rate, with 47 of 59 surveyed by Reuters (Oct 13th-20th) looking for the rate to be held at 0.1%, whilst 11 look for a 15bps hike to 0.25%; one outlier looks for a full 25bps increase to 0.35%.

Given the difference between market pricing and economist expectations, we would be cautious in using the word "consensus".

In terms of judging the likelihood of a rate increase at the upcoming meeting, it is worth looking at the above "rhetoric" section to judge the balance of views on the MPC. Given their votes on QE at the prior meeting, many desks are suggesting that Ramsden and Saunders will likely be in the "hike camp". Tenreyro and Mann are likely to vote for unchanged given their pushback on hikes. For the other five members, this is where things get a bit more complicated.

With the lack of pushback on market pricing and warnings on inflation from Bailey and Pill it could be argued that they are leaning in a more hawkish direction. If this was the case and they opted to vote for a hike, it is possible that Broadbent could avoid rocking the boat by conforming with this view given his tendency to stick with the majority. If he did adopt this stance, this would provide the numbers for a rate increase, however, given his alleged remarks at a recent private meeting, this is highly uncertain.

Elsewhere, Cunliffe and Haskel are viewed to be at the more dovish end of the spectrum, however, their lack of comments since the September meeting adds a degree of uncertainty to their potential votes.

Deutsche Bank (DE:DBKGn)'s base case is for a 6-3 vote in favour of a hike with a chance that lift-off could be delayed until December. SocGen suggests that December would be a more opportune time for the MPC to move on rates as it would provide more evidence on the impact of furlough drawing to a close. It is worth noting though that the December meeting will not be accompanied with a MPR and subsequent macro forecasts. The lack of press conference in December has prompted ING to suggest that a move on rates is more likely at the upcoming meeting whilst also noting that messaging from Governor Bailey has "been fairly blunt" adding that "he wants to act, and sees little point in waiting".

Ultimately, given the lack of pushback on market pricing the MPC might opt to act in order to avoid any credibility issues. If they do act, it is possible that they will try and temper some of the more hawkish expectations for 2022 rate hikes.

FORECASTS

For the accompanying forecasts, ING suggests that inflation projections two-three years out could be subject to downward revisions given that the models used by the BoE incorporate market-pricing. Such a revision lower could signal to markets that current pricing is too aggressive. As noted above, the disappointing Q3 data thus far is notably below the MPC's projections and as such this could impair the near-term growth profile. Analysts at SocGen have placed a lot of emphasis on the output gap within the MPR, whereby revisions could "move it into positive territory in the current quarter", adding that this would "be a signal of imminent policy tightening" and "validate the hawkish comments of Bailey, Pill and Saunders".

Current GDP forecasts:

• 2021: 7.25% (May. 7.25%)
• 2022: 6.00% (May. 5.75%)
• 2023: 1.5% (May. 1.25%)

Current Inflation forecasts:

• 2021: 4.0% (May. 2.50%)
• 2022: 2.5% (May. 2.00%)
• 2023: 2.0% (May. 2.00%)