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Summary
- Recent BoE comments have leaned more hawkish. Pill’s speech was most important, though confused in tone.
- June labour market and inflation data will be key to understanding the underlying trend, despite policymakers insisting single prints will not change the outlook.
- We think wage and inflation data details suggest the BoE should cut imminently. A delay will mean they must do more later.
Market Implications
- We stay positioned for BoE dovishness vs the Fed (long Z4 SONIA vs Z4 SOFR).
- However, given the risk of volatility in June services inflation, we avoid adding to dovish BoE positions until the data has confirmed trend normalisation.
BoE Comments Lean More Cautious
The BoE has finally broken its self-imposed pre-election silence. Comments have generally come hawkish, though Pill’s added confusion.
Haskel and Pill seem to agree single data prints are insufficient to shift the dial. However, we think they could be key to knowing whether underlying inflation and wage growth are normalising.
We expect data will continue to show normalisation, but potential inflation volatility in June could prevent an August cut. We consider all meetings into yearend ‘live’ and argue if the BoE does not cut soon, it must cut more aggressively later.
This could be an issue for the BoE. Most monetary policy transmission comes via the 3-5Y swap space. As such, they will seek to make their first cut hawkish. If they are playing catch-up, this will be harder.
We stay positioned for relative BoE dovishness vs the Fed via long SONIA Z4 vs short SOFR Z4. We would add to this if the data confirms our expectations.
Recent BoE Comments
Pill – 10 July
A hawkish but confused tone. This was not a speech that is gearing up for an August rate cut. Pill played down the current role of the MPR forecast and continues to watch labour market tightness, services inflation and pay growth.
Some of the confused messaging:
- Recent data suggests more upside risk in inflation persistence, but the data has been noisy.
- The longer they hold rates high, the more it bears down on inflation.
- He is concerned about inflation persistence and has not made his mind up on an August cut. But he also does not expect data released pre-August to change the picture much.
- Services inflation is too high (does not go into details as the minutes did), but also that inflation pressures have now been contained.
- He was uncertain of the current price-setting regime. It could be one in which BoE can just let second-round effects pass through and take the foot off the brake, or one where they cannot…
Haskel – 8 July
Reduced concern over labour market, but still cautious. He sees value pausing until confident underlying inflation is under control.
He presented a highly model-driven take (we wrote on this model last year), explaining why the shift in labour market dynamics in March allowed him to back a pause. But he remains concerned the labour market is not back to normal yet.
On inflation, he saw encouraging signs of normalising expectations but noted the wage/price system had taken a big shock. He wants to stay on hold until he is more certain underlying inflationary pressures have subsided.
He was concerned about an impaired labour market, albeit less so than pre-ONS revisions. On wages, he sees second-round effects having peaked in 2023 and disappearing by late 2024.
Mann – 10 July
Emphasised strength of price pressures, noting the 2% target will only be briefly met before inflation bounces. Wages and services prices remain too far above target.
Data: GDP, Inflation & Labour Market
Inflation and Labour Market Conditions Are Weakening
The BoE’s caution on inflation is dictated by concern over second-round effects in wage growth feeding into services inflation pressures. To understand the dynamic here, we focus on:
- Pay growth in consumer-facing sectors.
- Price pressures in sectors where wages are a big driver of cost.
On pay growth, consumer-facing services wage growth has lagged other sectors (Chart 1). Ultimately this suggests second-round services sector inflation pressures are suppressed.
On inflation, BoE minutes tell us they are looking through ‘index-linked/regulated’ service cost rises (so it was surprising to see Pill still referring to services inflation as a whole). We have broken that section out, as well as the more wage-intensive sectors (Chart 2).
The picture there is unclear. Wage-intensive services inflation saw momentum accelerate in March and April, but May looked normal. If we get normal-ish outturns again in June, it would strongly suggest March/April were the exceptions and be a dovish outturn.
Hotel prices could see volatility in June. However, this should fall out in July. If, as we expect, the sticky services sector continues to normalise, it would suggest more easing in 2024 than currently priced.
Output Data and Surveys Hawkish, Labour Market Loosening
GDP surprised to the upside in May, suggesting a further overshoot versus BoE estimates for Q2 of around +0.5% QoQ (Chart 3). This should be taken as moderately hawkish for the BoE, given the overshoot versus expectations. But right now, economic growth is taking a backseat to the labour market and inflation data. There could be a weather dynamic at play. Services led growth, and May was one of the warmest on record.
- UK financial conditions continue to tighten, albeit more slowly (Chart A1) – DOVISH.
- UK inflation expectations remain strongly anchored across the financial markets, consumers, and businesses (Chart A2) – DOVISH.
- UK regular private wage growth remains high and overshooting BoE expectations (Chart A3) – HAWKISH.
- The UK labour market is continuing to loosen, albeit steadily (Chart A4) – MIXED.
- UK Consumer and business outlooks are continuing to improve, even while manufacturing outlook remains subdued (Chart A5) – HAWKISH
- UK inflation has ticked up recently, particularly in services. However, wage intensive services inflation looks to be normalising (Chart A6) – MIXED.
Appendix Surveys and Data
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