BoE Monitor: Why Cut in June, Not August?

Summary

• The BoE has announced Broadbent’s replacement in Lombardelli. Unsurprisingly, the market has taken it hawkishly, but we are wary of reading too much into it.
• The arguments for waiting until the August MPR for the BoE’s first cut have merit. But if the data develops as we expect, they may be unable to wait past June.
• Arch-hawk Mann has given a new reason to be hawkish – but in our view, the issue she raises (apparent consumer immunity to hikes) is a non-starter.

Market Implications

• We still like receiving 2Y GBP swaps vs paying 2Y EUR.
• If near-term data allows, we would look to receive outright in the GBP short end.

BoE Likely to Leave Rates Unchanged

The replacement for Deputy Governor (for Monetary Policy) Broadbent has been confirmed as Clare Lombardelli, current OECD Chief Economist and former HMT economist. She starts 1 July. This market took this hawkishly, likely because:

• She was quoted recently warning CBs are not ‘out of the woods’ yet on inflation.
• The OECD currently has a stronger outlook for UK growth than the BoE and forecasts higher UK CPI inflation than the rest of the G7 in 2024 and 2025.

Moreover, recent MP criticism of Broadbent for not disagreeing enough with the Governor in his policy votes presents a risk she may come out hawkish – and willing to vote as such. Her time at HMT has also triggered criticisms of the BoE and Treasury being too connected, which she may want to lean against.

We refrain from reading too much into the appointment for four reasons:

1. Her comments about inflation were in reference to the broader G7. This is probably more a reference to the US, where growth continues to steam ahead, than the UK specifically (Charts 1 and 2).
2. The bulk of her career has been at HMT, and she started out at the BoE – in that regard she remains something of an insider who may not want to rock the boat.
3. BoE models will have been updated/reviewed by the time she joins (after Bernanke’s review, aimed to be completed by Spring).
4. She will begin after the June meeting (when I expect the BoE to cut).

Where Will Data be By June?

Since the start of the year, the market has quickly switched from pricing a first cut in May to August. While most of this move was driven by Fed pricing, undoubtedly, the tight labour market data we saw in the upgraded ONS numbers played a role too (that was what caused us to rethink our original expectation for a May cut).

Would the BoE prefer to wait until the August MPR to commence cutting? In short, yes. That way they will have refreshed forecasts. However, we think the data may not allow that delay.

History suggests this is often the case, too. Since 2006, roughly half of the cutting/hiking cycles began on a non-MPR/inflation report meeting. Waiting for an MPR has tended to occur when the BoE is attempting policy tweaks/one-off moves (August 16, November 17, August 18). But when the data forces their hand, they tend to not care so much about it being on a non-MPR date.

So, will the data prove sufficient for a June cut? While we are not forecasting September 2008- or March 2020-style crashes, we think that come June the data will be sufficient to force a cut. By then, the BoE will have May CPI data and April wage data. We expect the former to reveal a significant undershoot versus target in headline CPI, and a fast core disinflation (Charts 3 & 4).

Note, this is assuming strong rental inflation continues, and includes the one-off jumps in March methodology changes.

Meanwhile, base-effects in wage growth should allow for a decent downside divergence in private wage growth from April (Chart 3).

Our conclusion, therefore, remains that by June, the MPC will have the data necessary to cut rates. We continue to see value in receiving 2Y GBP swaps vs paying 2Y EUR.

Mann-y Ways to be Hawkish

Mann remains the most hawkish member of the policy board. But her recent comments are a little odd. In her opinion, inflation could be sustained by ‘lack of consumer discipline’ from wealthier consumers, who are immune to higher interest costs. While begging for “consumer discipline” is not a million miles from the kind of insensitive comment that landed Pill and Bailey in hot water, there may be some truth to it. Certainly, net savers will have benefited from the rise in rates.

However, her conclusion is at odds with logic. If wealth Britons are immune to policy rate level (perhaps even benefiting from them), why does it make sense to keep rates high?

It is hard to say how much emphasis Mann will actually put on this rationale, given there have been no shortage of reasons she has touted for hawkishness since the start of the crisis. In fact, she may change tack soon though. In her latest speech, she judged that the vote for another hike in February was ‘finely balanced’. The January CPI outturn (and the delayed discounting in accommodation prices we had expected) should have sapped some of the concern she has based on the strength of SA services inflation (Chart 1 – she uses different SA, but the point holds).

Appendix – Surveys and Data

Henry Occleston is a Strategist, who focuses on European markets. Formerly, he worked in European credit and rates strategy at Mizuho Bank, and market strategy at Lloyds Bank.

(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.)