BoE React: Fly Me to the June

Summary

• The BoE struck a more dovish tone, with comments suggesting they are strongly considering cutting in June if the data allows. This remains our base case.
• Bailey strongly indicated that they expect to need to cut more than the market is pricing, but that they will attempt to cut hawkishly (i.e. keep market pricing from running away).
• More hawkish near-term forecasts are a little puzzling given the more dovish tone. The BoE seems more focused on the detail of data (in particular, evidence of inflation persistence).
  • GDP growth was revised higher. The BoE will be most interested in consumption.
  • Near-term inflation was revised higher on services, food and HH energy prices.
  • The BoE accept that unemployment rate is not very useful right now. They revised down their profile there but kept wage growth unchanged.
• We continue to see room for the persistent elements of inflation to undershoot MPR forecasts in the near-term.

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).
  • On balance there looks to still be value for now in paying 2Y EUR vs 2Y GBP.

Bad June Rising

Yesterday’s BoE meeting added to my feeling since February that (if the data comes as we expect) they will cut in June. Bailey may have pushed back on the idea that a cut then was a “fait accompli”, but the very fact they were discussing as much (and that Ramsden backed a cut now), suggests it is a strong possibility in their view.

The policy statement was not so dovish as it could have been, but the presser provided soundbites which were much more in line with my expectation.

In brief the presser suggested their thinking was as follows:

• If the data allows, they will cut (I expect this will be the case by June).
• They will probably need to cut more than the market is pricing.
• They will have more data by the June meeting (i.e. June is live).
• A cut does not mean easy policy (i.e they’ll pursue a hawkish cut, as I’ve warned).
• They are focused on inflation persistence signs – headline data does not need to match or miss vs forecasts for a June cut – it’s the details that matter.

These points taken together add to my conviction for a first cut in June, but upcoming data (and, in particular, the detail), remains key to this view.

At this stage, with still only 60bp of cuts priced for the whole year, I still see value positioning for relative BoE dovishness vs other central banks.

In our model portfolio we are long Z4 SONIA vs short Z4 SOFR, positioned via 2s10s UK/US box for UK steepening (supported by elevated UK supply). On balance there looks to still be value for now in paying 2Y EUR vs 2Y GBP.

Forecasts Send Mixed Signals

As expected, higher market priced bank rate subdued inflation into the medium-term in the MPR’s market-based forecasts. Here, headline inflation now drops to 2% near-term, bounces up to 2.6% into year-end, before falling consistently thereafter (ending at c.1.5% in three years’ time).

The medium-term undershoot versus target aligns with the notion that they expect to cut more than the market is pricing. Beyond this though, it is not very informative.

Instead, the more interesting revelation is that the BoE is somewhat more bullish/hawkish in the near-term than they were previously. Looking at their flat-bank rate estimates, they have revised up growth, lowered unemployment, and raised the inflation profile.

More hawkish forecasts sit at odds with their more dovish tone. This could mean the BoE are less dovish than their comments suggest (they are keen to cut soon, but near-term data is getting more hawkish), or more so (they are keener to cut than before despite the near-term outlook being more hawkish).

Either way, Bailey made it clear that a meet/miss of the data alone would not alone be sufficient to cut. As such, we will continue to focus on the details – which we expect will allow them to cut in June.

Growth Outlook More Bullish

Adjusting for interest rate impact, the BoE is looking for a much stronger growth outlook than they had pencilled in in February. Even so, this morning’s Q1 preliminary outturn beat expectations (Chart 1).

Given their mandate the BoE will probably care most about consumer contribution. Here, it looks like the consumer was probably a bit stronger than they had expected.

Importantly, accommodation and food services dropped marginally on the quarter, but consumer facing retail grew quite strongly. The former is probably the more important sector for the BoE right now, given their focus on inflation persistence and the importance of accommodation and food services in services inflation.

Inflation Revised Up on Energy and Services

Though not as extreme as the GDP profile, it is telling that the BoE raised its headline inflation forecast when adjusted for interest rate impact (Chart 2). Bailey remarked that a few dovish adjustments to assumptions had been made:

• Import price rises now assumed to have more fully transmitted than previously. This goes some way to explain the downward revision in core goods.
• Second-round effects now assumed to fade faster than previously. This does not appear particularly evident in the forecasts.

While part of the upward revision is due to higher expectations in gas/electricity and food prices, there is a considerable upward contribution from services inflation (Charts 3 & 4). We see downside risks there (Chart 3)

Bailey was explicit that the decision whether to cut or not would depend on the composition of inflation – in particular, signs of persistence fading faster than forecast. We expect that we will start to see this in the April numbers if hotel inflation pares back as we expect.

Who Knows What’s Going on With the Labour Market?

The BoE sees ‘substantial’ issues with the ONS’s LFS data (from which we get the unemployment rate). There has been a lot of volatility of late, and participation rate has driven a significant chunk of the recent change. The BoE sees risks that participation could be significantly higher than estimated.

It is hard to know how much to take from the BoE’s downward revision to unemployment rate in its unchanged bank rate forecasts (Chart 5). Some of it is down to higher assumed employment, but some of it is due to participation rate assumptions.

An interesting conclusion that the BoE made was the fact that private sector employment seemed to be lagging public sector, which would (all else equal) make the rise in employment less inflationary.

I think the BoE will look through whatever LFS data says so long as disinflation is continuing.

In wage growth, the BoE’s forecasts have not changed materially, other than a slightly different pattern of volatility (Chart 6). Our estimates suggest a lower profile from April. The rise in minimum wage then will offset some of the base-effect, and there is upside risk before then of companies frontloading the rise in March, but I expect a continued slowdown ahead.

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.)