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Summary

• We expect the BoE to hike by 25bp this week, although the content of the statement and the forecasts will be important to watch for signs of dovishness.
• The vote pattern will likely be 7:2 in favour of a hike, while the forecasts will need to be updated to reflect a more hawkish near-term GDP and inflation outlook.
• The BoE will have a hard time pausing until inflation properly slips and labour market weakness kicks in. We expect that will come later in Q2, leaving a good chance for June to be the final hike.
• The market is probably underpricing the prospects for BoE cuts to begin before the end of the year.

Market Implications

• If the BoE does show indications that they may be looking to pause in the next few meetings, there should be good value positioning for a tighter spread between 2Y GBP and EUR swaps.

Current BoE Forecasts

Link to Most Recent BoE Meeting Minutes

BoE to Hike, but Details may be Dovish

While we have previously been very dovish on the BoE, the recent data outturns have led us to shift our expectations toward further hikes. And while the likely 25bp remains important at the May meeting, we will also see the updating of the monetary policy report (MPR) and with it the Bank’s forecasts. At this stage, it seems likely that this will mean an upward revision to the near-term GDP and CPI forecasts (Charts 1 & 2). Further out, it is likely that inflation will continue to undershoot the target, but potentially to a lesser extent than previously. Expectations around the labour market will be important to watch.

While wage outturns have been consistently stronger than expected, Chief Economist Pill has noted its momentum is slowing, and there are nascent signs of labour market loosening. It will be important to watch whether the BoE reads further into this. Wage growth has been a thorn in the side of MPC policymakers, not only in terms of its overshooting versus forecasts, but also in terms of inviting PR gaffs in comments. The latest of these came via Chief Economist Pill, they were explicit in pinning the blame of persistent inflation on both employers and employees (although the papers have jumped on the latter).

The ECB has, by contrast, for some months been discussing the role of rising corporate profits in driving inflation. This week’s BoE meeting could provide an opportunity to put more emphasis on the subject, providing an equal opportunity to shift away from the sensitive subject of real wage decline. Such comments could, however, be taken as a dovish signal that they can live with such high nominal wage growth as they are currently seeing.

Economic forecasts will need to be hawkishly revised. However, given the weakening in the labour markets I expect the hike will come alongside some more dovish commentary. At this stage I expect this will set the stage for the BoE to hike now and again in June, but be able to pause thereafter. Meanwhile, I expect the voting pattern will match the previous meeting (7:2) in favour of the 25bp hike, although there is a risk (given we haven’t heard from her in a while) that Member Dhingra will back the majority given the recent data prints.

Watch for Signs the Market is too Hawkish

Market pricing right now is looking for a peak rate just shy of 5%. While the tone out of this upcoming meeting could greatly change our own view, right now our lean is that the market is overpricing future hikes. We expect that the labour market will continue to loosen and inflation (particularly food) will see strong near-term deceleration. That would set the stage for bank rate to reach its peak in June at 4.75%. In such an instance, it would also open the possibility for BoE rate cuts before the end of the year. Hence, unless the BoE shows clear indications that they will continue to hike into such a situation, we would see room for paring current market pricing (Chart 3).

Fade 2Y GBP/EUR Swap Widening

We see value to fade recent ECB dovishness, and if the BoE does show signs they may be ready to pause before the market is pricing, it could be profitable to position for 2Y GBP/EUR swap spread tightening (Chart 4). An alternative view would be to position long EUR/GBP (which correlates well with the spread), although there are other factors at play on the EUR side which may make that less attractive (we like to be tactically short EUR/USD).

Recent Voter Comments

Stress, Surveys and Economic 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.

Photo Credit: depositphotos.com

(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.)