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Monetary Policy & Inflation | UK
Monetary Policy & Inflation | UK
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The BoE held rates steady at their September meeting. But despite near unanimity in the decision (only Dhingra voted to cut) and the insertion of a ‘gradual approach’ to loosening, there remain reasons to be dovish.
The most recent labour market and inflation data keeps alive our expectation that the BoE can cut twice more this year. This is because core services inflation are undershooting, and the labour market continues to loosen (Charts 1 and 2). Data volatility is probably why the BoE is looking through the undershoots versus their expectations in the near term, but they will struggle to do so if this persists to the next MPR.
There is a fiscal risk to our view. We anticipate deficit spend will focus on investment (rather than consumption) so the BoE will look through the bulk (they will probably not want to bake in too much disinflation from supply-side policies). Yet the lower BoE gilt sales presents a direct transfer of spending power to the Treasury, which could prove more expansionary than they currently forecast.
Also important is that MPC hawks are increasing focus on consumer weakness. For context, the MPC’s assumption is (as Greene notes):
Unfortunately for the UK economy, it is not that ancient symbol of growth and rebirth in British folklore, the Green Man, that has reared its head. Instead, it is two of the most hawkish external MPC members, Greene and Mann, who in their recent speeches have focused on the UK consumer. Far from a sign of new growth, both are increasingly acknowledging the weakness in the balance sheets of marginal consumers and have set out various ways to explain this.
We have been bearish the UK consumer for some time, particularly based on how UK policy transmission is occurring.
The crux of the speeches was that while both remain hawkish in their outlook, this is more on the back of fears of structural shifts, rather than what they are seeing in the data currently. As such, there could be room for this hawkishness to fade further if these risks are not realized.
Arch-hawk Mann’s view:
But hawkish still as:
Hawk Greene’s view is:
Three ways to explain weak UK consumption: two hawkish, one dovish:
But she remains hawkish as:
Mann argues simply that UK services inflation has really been much worse than in the Eurozone. But looking at YoY rates, we can see that the bulk of UK CPI beats in services come down to overshoots in Communications, Rental, Water, Transport services and Hospital Services (Chart 3).
In other words, recent UK inflation has been worse in sectors that are either index, or non-wage cost driven (fuel, previous inflation, mortgage cost etc.). But prices in wage-intensive services (the stickier type) are undershooting in the UK.
Greene’s hawkishness comes from the risks of lower bank rate seeing consumption bouncing back. But her intertemporal analysis ignores that even within the survey she cites, higher mortgage/housing cost outweigh higher interest on savings in all but the highest two quintiles – i.e. net-finance expense/receipt has probably been negative in all but the richest quintiles.
The net benefit analysis also ignores the fact that mortgages (and other consumer credit) tend to charge higher rates than savings pay and that interest earned is taxed. ONS data suggests that even in nominal terms the net-interest income gain has been small (Chart 4).
Meanwhile, despite her hawkishness on the possibility for savings to crash back, ONS savings data suggest that intertemporal factors explained less than half of new savings in Q1, precautionary motives explained even less (these are the elements that should be run down as bank rate is cut, Chart 5).
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