BoE Preview: Dovish MPR Should Open Way for Cutting

Summary

• We expect the BoE will leave rates unchanged at next week’s meeting. However, a more dovish inflation forecast should open the door to explicitly discussing cuts.
• The BoE will ultimately want their first cut to be a hawkish one, and for the market not to price too much subsequent easing – a well telegraphed cut (in June or August) is the best way to ensure this.
• We expect Bailey will be explicit in backing the BoE’s capacity to diverge from the Fed, if needs be. The recent shift in UK swap curves, on the back of Fed hawkishness/US data, should be something they will want to squash.
• We do not expect the BoE will have discussed/have any intention on discussing an early tapering of QT just yet.

Market Implications

• The market is not pricing enough BoE easing this year in my opinion. We continue to see value:
  • Being long Z4 SONIA vs short Z4 SOFR, targeting 0.75 (equivalent to about two more BoE cuts than Fed cuts in 2024.
  • In our 2s10s UK/US box (supported by elevated UK supply).
  • We have reduced our conviction on our trade paying 2Y EUR vs 2Y GBP. We will revisit the trade post-BoE.

The BoE Could Start Teeing Up a Cut

The BoE will announce policy and update forecasts on Thursday. We expect they hold rates unchanged, but signal they are looking to cut sooner rather than later. While we initially anticipated a first cut in May, that scenario is now less likely, though still a tail risk.

We expect a 1:8 vote for a cut, with Dhingra being the only in favour. And while Ramsden’s recent remarks hint at a possible support for a cut, we see it as more likely he moves in line with the other internal voters.

We expect the tone will be quite a bit more dovish, opening a way to a cut in June or August (my base-case is June). Here, much will depend on the updated forecasts.

On this front, we expect:

• Near-term inflation outlook will be revised downwards on recent misses, and fuel tax freezes (Chart 1).
• Medium-term forecasts will also be revised lower on the back of higher market pricing in the bank rate. Analysis of changes should focus on their flat-bank rate model. we expect it will signal that the BoE needs to ease more than the market is pricing.
• Services inflation (a big focus) has moved roughly in line with MPR estimates from February – but I see room for a lower trajectory further out.
• The unemployment outlook is uncertain, given that LFS unemployment rate data remains unreliable (Chart 4).
• But the decline in vacancies suggests continuing labour market loosening.
• GDP growth has been a little stronger than expected, but this is not likely to figure heavily into inflation outlook (Chart 5).
• Wage growth looks relatively in-line with previous forecasts – we expect an undershoot from April, but for now the BoE may leave expectations unchanged (Chart 6).

Dovish Forecasts Likely to Encourage Dovish Tone

Much has been made of the BoE’s apparent internal disagreements on the back of Chief Economist Pill and Deputy Governor Ramsden’s recent speeches. We see the recent trend as consistently dovish. Pill in his (relatively unhelpful) speech continued to see cuts as some way off from March, but not contradictory to tight policy, while Ramsden supplied strong rationale for easing soon.

Even hawkish Haskel has conceded inflation expectations remain anchored (our long term view), even if Greene and Mann disagree (Appendix: Chart A2).

We expect a lower inflation profile to provide Bailey good cause to sound much more dovish. We expect the BoE will seek to make their first cut a hawkish one. If that is the case, they should use this opportunity to ease market expectations into modest easing. We will watch for comments pointing towards them cutting if forecasts are met.

The market could end up pricing much more dovishness if they opt not to telegraph as much. It means they would have to pivot quickly as the data undershoots ahead (as we expect). In his last speech, Pill seemed cognisant of this risk.

An important topic that will likely need to be broached is the potentially significant impact on financial conditions of Fed policy. Lately, financial conditions appear to have tightened slightly, largely on the back of yield curve moves (Appendix: Chart A1).

The tightening impact of market pricing will be obvious from the forecasts, and the BoE will need to answer questions on whether it will diverge from the Fed. I expect Bailey’s answer will be that they have no problem diverging – the question will be whether the market believes this.

Still Value Positioning for More BoE Dovishness

The market is pricing 46bp of cuts this year. This seems far too little given the recent trajectory of inflation momentum (Appendix: Chart A6).

We continue to see value:

• Being long Z4 SONIA vs short Z4 SOFR, targeting 0.75 (equivalent to about two more BoE cuts than Fed cuts in 2024).
• In our 2s10s UK/US box (supported by elevated gilt supply).
• We have reduced our conviction on our trade paying 2Y EUR vs 2Y GBP. We will revisit the trade post-BoE.

BoE Unlikely to Signal a QT Taper Yet

For now, we do not expect the BoE will signal an early taper to QT. The rationale for an early taper would be twofold:

1. Active bond sales are costly to the Treasury (which must fund APF losses).
2. Elevated bond and money-market yields (and swap rates) means more tightening and could dampen monetary policy transmission.

However, we do not expect they will signal any change just yet for four reasons:

1. The BoE is independent to the Treasury, and if it really wanted to help with the deficit, cutting rates would make more sense.
2. The BoE has telegraphed its bond sales out to September, unless something urgent occurs, it can wait at least until then to stop.
3. Bailey has been explicit in his rationale winding the balance sheet down.
4. QT is not the main policy tool. If financial conditions are too tight, a bank rate cut is the way to loosen.

Appendix

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.)