BoE Monitor: Hawks Focus on UK Consumer

Summary

• The BoE voted (almost unanimously) not to cut in September and explicitly guided a ‘gradual approach’ to easing.
• However, we think recent data continues to suggest dovishness.
• Meanwhile, Greene and Mann (hawks) show increasing concern with consumer weakness.
• We are less optimistic than both on the outlook for the UK consumer based on the speed and manner of policy transmission and the recent trend in household wealth and savings data.
• Both members remain hawkish – more so on possible risks than current data. If the risks do not materialize, it opens scope for more dovishness.

Market Implications

• We remain long 10Y Gilts and still see the BoE cutting twice by year-end

Two BoE Cuts Still Possible by YE

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):

1. Consumer-facing firms do not feel able to pass on costs.
2. Consumption spend will pick up ahead.

Greene-Mann on UK Consumption

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:

• Consumption has perhaps been permanently knocked off pre-covid trend. There is an accumulation of evidence that it is weakening particularly in middle-income deciles.
• Consumer-facing firms are less certain about their pricing power.
• Evidence is growing that inflation expectations have re-anchored.

But hawkish still as:

• Labour productivity is too low given wage growth. Structural behaviours in labour market are embedding inflation.
• Services inflation is sticky, while goods deflation is unlikely to last
• The neutral rate is likely higher now. Expect inflation to stay above target for extended period.

Hawk Greene’s view is:

Three ways to explain weak UK consumption: two hawkish, one dovish:

• Precautionary savings (hawkish) – price of essentials rose more than discretionary – real volumes of consumption have shifted towards essentials and away from discretionary (particularly durables).
  • Savings data suggests consumers increasingly choosing to save not spend disposable income. If this is the case, then it will reverse as BoE cuts.
• Intertemporal substitution (hawkish) – higher rates incentivize ‘save now, spend later’.
  • Considerable flows into interest bearing time deposits from 2021-2023 support this thesis.
  • Surveys suggest all but lowest income decile chose more savings due to higher rates.
  • She would expect cutting rates to have opposite impact.
• Cashflow channel (dovish) – higher bank rate resulted in higher aggregate household interest income, but it has been a shift of wealth from borrowers (spenders) to savers.
  • Benefit to savers from higher rates already seen, but cost to mortgage holders not fully fed in, so consumption could remain subdued ahead.

But she remains hawkish as:

• Risks may be skewed both ways on consumption, but her focus remains on risk that it recovers faster and that consequently firm pricing power rises.
• She sits in MPC Scenario 2 situation (some slack in economy is needed to bring inflation back down), but also sees high risk of Scenario 3 (structurally higher rates needed)

Why We Remain More Dovish

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).

(The commentary contained in the above article does not constitute an offer or a solicitation, or a recommendation to implement or liquidate an investment or to carry out any other transaction. It should not be used as a basis for any investment decision or other decision. Any investment decision should be based on appropriate professional advice specific to your needs.)