The MPC has cut Bank Rate to 5.00% with their latest policy announcement, meeting market expectations, but frustrating our call that had looked for a first rate cut in September.
Even so, today’s decision was “finely balanced”, a point reflected in both the policy statement and the 5-4 vote split. Moreover, as noted in our preview of this latest policy meeting, if we were in charge at the BoE, a rate cut would have been our choice too on balance. While recent headline data prints have been stronger than expected, the underlying details have been much more benign. This appears to have been recognised by enough of the MPC to see a Bank Rate cut today, albeit by the barest of margins. Looking forward, we still think markets are underestimating the speed at which the MPC will ultimately need to cut rates.
We look for between two and three further rate cuts this year, with the September meeting likely to be finely balanced once again.
Sifting through the details, there was a further move away from basing decisions on incoming data in today’s communications, instead placing greater focus on the Bank’s modal forecasts for inflation. Conditioned on the market implied bath for Bank Rate, these now show CPI falling to 1.7% in 2 years and 1.5% in 3 years, well below target in both cases. This means that the MPC now expects inflation to fall further than previously expected in the May MPR, despite conditioning on a lower path for Bank Rate. It also suggests increased confidence that CPI growth is set to return to target on a sustained basis, even considering the recent strength across both GDP and services inflation.
More importantly, this looks like a steer that markets are underestimating the likely pace of Bank Rate easing.
Admittedly, there is still some need for caution when pricing in further near-term easing. A 5-4 majority is only the barest of margins, and for some of the members voting for a cut today’s decision was close given that “Inflationary persistence had not yet conclusively dissipated, and there remained some upside risks to the outlook.” This was embedded in the latest Bank staff forecasts, which show mean CPI inflation at 2.0% and 1.8% at the two and three-year horizons respectively. As noted by Governor Bailey in the press conference following today’s announcement, the upside skew in today’s forecasts can be viewed as an alternative scenario where inflation remains more persistent, a change introduced in response to the recent Bernanke Report.
That all being said, we think wage growth should cool sharply in the second half of the year, accompanied by further loosening in the labour market and continued disinflation progress.
Given the Bank’s newfound willingness to look through upside headline surprises and focus on the details, combined with a meeting-by-meeting approach, this gives us increased confidence that more rate cuts will be delivered over the remainder of the year. Indeed, Bailey indicated that the MPC expects an uptick in August’s services inflation, preparing markets to look through any short-term resilience on that score, a fact we think is notable given that this data is published just one day before the September policy meeting. All told then, market expectations now price 1.5 rate cuts for the remainder of the year, with a 25% chance of a cut in September. We think this is too low given today’s communications. If we are right, faster-than-expected easing is likely to see the pound treading water against the dollar in the short term, before favourable growth differentials support sterling upside further out, with a break of 1.30 still likely by year-end for GBPUSD.