BoE Preview: MPR to Create More Dovish Foundation

Summary

• With little new data, I expect the BoE will leave bank rate unchanged at 5.25% again.
• The voting pattern will be interesting, with room for change among external voters:
  • I expect a reduction in votes for hikes; Mann could be the sole backer.
  • I expect Dhingra will be the sole voter for a cut.
• A more substantial change in tone (and voting) could come in March once we have corrected LFS data. I expect that to open the door to a cut in May.

Market Implications

• We still see value being long SONIA futures, positioning for a May cut.
• Paying 2Y EUR swap against 2Y GBP looks attractive – this week could provide a good entry point if EZ inflation surprises to the downside.
• In FX, we remain bearish GBP vs USD.

BoE Likely to Leave Rates Unchanged

The BoE will announce policy on Thursday and update its forecasts. I expect they will vote to keep rates stable, but it will be interesting to see how dovish the tone shifts on the updated forecasts.

In the vote, I expect the hawks to shift more towards a pause. There is a decent risk that Haskel and perhaps Greene shift to vote for no hike. If Mann (the arch hawk) was to shift too, that could drive real market reassessment. Such an outcome is not beyond the pale given recent data, but I would be cautious reading too much into it alone.

Meanwhile, Dhingra will likely vote for a cut, but probably alone. There could be a temptation for others to join her, but for now I expect the internal voters will remain rallied around leaving rates unchanged.

Dovishness to Build in Forecasts

In the monetary policy report (MPR) forecasts, wage expectations and inflation will need downward revision in the near term given recent misses (Charts 1 and 2). The numbers alone do not tell us everything (we know the BoE will fudge them when they need to, and trend back to 2% is almost guaranteed). However, it should be hard for Bailey to push back on market pricing when inflation looks likely to touch 2.0% before the summer.

The medium-term inflation outlook will remain supported by lower market pricing for cuts: currently at 200bp over the next two years (Chart 3). A simple analysis of end-horizon MPR forecasts for CPI, looking at the difference between those based on market price of rates and constant rates, suggests the lift could be up to 0.8ppt. Lower energy costs will offset this.

Hawkish assumptions on the unemployment rate should also keep end-horizon CPI comparatively elevated. Recent experimental numbers look artificially subdued (Chart 5). This low and flat unemployment rate will probably allow the assumption of wage inflation to remain hawkish, which will probably mean they soften the expectation for wage growth decline into mid-2024.

As such, I expect we will only get the more serious dovish tone (and cut) at the May MPR, once we have the corrected labour market data (scheduled for February, could well be delayed again).

For now, we still see value being long SONIA futures, positioning for a May cut.

Paying 2Y EUR swap against 2Y GBP looks attractive – this week could provide a good entry point if EZ inflation surprises to the downside.

In FX, we remain bearish GBP versus the USD.

BoE Hawkometer

Appendix Graphs

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.)