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Summary
- A September cut may require a continued undershoot in headline and services inflation (our expectation) and signs of further labour market easing (less certain).
- The September meeting will also see a decision on QT for the year ahead. Given the maturity profile, the risk is skewed towards slower active sales.
- This would present more of a policy loosening than the BoE have admitted and could offset the need for a cut (though they, again, will not admit it).
Market Implications
- The risk of a September cut is probably being underpriced, but the current risk-reward is not attractive enough to merit a trade.
- We still like long gilts – targeting 3.5% in the 10Y yield.
The Speed of Tight
At the last BoE meeting, the MPC voted 5:4 to cut 25bp. Importantly, the pass-through of mortgage rates continues. As such, the cut was not so much an easing as a slowdown in tightening (Chart 1). We have written in more detail on UK policy transmission previously.
September Decision in the Balance
The 19 September policy decision (unfortunately not the 21st, which would have allowed an Earth, Wind & Fire pun) is in the balance right now. We have previously covered the mixed outturn of the last labour market print (lower unemployment but slowing wages) and also the dovish inflation surprise (in line with our expectation).
For the BoE to cut in September, it will probably need to see:
- Inflation continue to undershoot expectations, particularly in services (our base case; Charts 2 and 3).
- And signs that the labour market is indeed loosening – for instance via further undershoot in private regular wage growth and/or a tick back up in unemployment (Charts 4 and 5).
The market is probably underpricing the risk of a September cut (7bp priced), but the risk-reward is not attractive enough to enter a position.
In the Line of QT
The BoE will also set the path for winding down its balance sheet at the September meeting. While this decision should (according to BoE estimates) happen in the background (separate to the decision on bank rate), a decision to slow active sales could reduce the desire for a rate cut.
Recall:
- In September 2022, the MPC voted to reduce its government bond holdings by £80bn over 12 months (c.£40bn maturing, £40bn sales).
- In September 2023, they voted to reduce by £100bn (c.£55bn maturing, £45bn sales). In the 12 months from September 2024, c.£87bn in gilt holdings will mature.
So we can reasonably assume the BoE can afford to slow its sales significantly, while retaining the same or faster winddown in BS.
To retain the drop of £100bn seen in the 12 months to September 2024, the BoE need only sell £13bn of its holdings. We consider this the likely lower bound of the possible active gilt sales. We think the upper bound would be to sustain the £45bn pa pace of sales (Charts 6 and 7).
On the possibility of slower active sales, we continue to like long gilts and target 3.5% yield in the 10Y.
Importantly, further out slower active sales will provide fiscal headroom to the Treasury (something the BoE helpfully omits from all analysis). As such, we consider this a far stronger easing measure than the BoE suggests, which will affect our view on policy further out.
We will revisit the implications for fiscal policy ahead.
(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.)