BoE React: Hawkish Forecasts, Dovish Tone; A Hard Sell

Summary

• The BoE hiked 25bp as expected and hawkishly revised their forecasts– in line with broad expectations.
• The tone of the presser was aimed (as we had expected) at tacking a dovish tone to caveat the apparent hawkishness of the forecast revisions.
• However, clearly press conference attendees (and the market too) are having trouble buying the dovishness.

Market Implications

• The release was as expected and does not change our expectation that the BoE will hike once more in June and pause in August. Next week’s labour market data will be important, especially in terms of wage growth.
• If private wage growth shows signs of slowing, expect GBP weakness and short-end GBP rates strength. We continue to see value positioning for short-end GBP swaps to tighten to EUR.

BoE Hikes with Hawkish Forecasts but Comparatively Dovish Tone

The BoE voted 7:2 to hike 25bp, as expected, while their forecasts were shifted materially more positive/hawkish to account for data and policy since the last MPR. Governor Bailey, Broadbent and Ramsden were on the back-foot throughout the press conference, with their credibility and track-record under attack.

On the whole, the meeting did not greatly change our perception for the BoE: they are keen to pause, but have been prevented by recent data. Despite their hawkish GDP forecast revisions, their focus remains services inflation, wage growth and labour market tightness. As such, next week’s labour market data (16 May) will be very important, in particular we will be watching private regular wage numbers for indications of a slowdown in growth. Our core view remains that they will hike again in June and pause in August, opening up the possibility of cuts towards the end of the year.

GDP: Revised Higher but Still Weak

The GDP profile was revised to be roughly flat YoY for the first two quarters of the year before rising higher and sooner than in the February MPR (Chart 1). This morning’s Q1 GDP numbers have already proven slightly stronger than this, although the sharp deceleration in March is worth bearing in mind.

Despite the fact that this MPR provided the largest upward revision in MPC history, Governor Bailey was careful to note that GDP growth remains low versus historic trend and that it is largely related to lower gas prices, positive global developments (EZ and China in particular), and support from the Spring Budget. The risks to the forecasts were deemed to be balanced, and Bailey noted that only a small proportion of the rate hikes performed thus far had fed into the mortgage market (c.70bp out of 300bp in mortgage rate rise).

The Labour Market: A Slower Loosening, But Focus on Wages

The labour market was conceded to have loosened, but by less than previously expected. Meanwhile, the unemployment rate is now expected to remain close to recent lows into 2024 (Chart 2). That is despite survey data on hiring continuing to ease. This puts the MPR’s forecasts for unemployment at a very historically shallow rate – consequently the room for a miss through Q2 is also increased.

However, the BoE are more concerned about wage growth. They expect private pay growth to decelerate through the remainder of the year – although this would constitute only a slight slowing of recent trajectory (Chart 4). Bailey, in his remarks, noted that wage growth had tracked roughly in line with their February expectations, while Broadbent added that the drivers of wage growth have been mostly cost-of-living squeeze rather than unemployment driven. The BoE reported signs that this squeeze is starting to fade. Together, this is another relatively dovish appraisal. Next week’s wage data will be key, and given the relatively hawkish projections, there could be room for disappointment.

Inflation: Raised Across the Horizon, but Base Effects Important

The new profile across the projection horizon reflects the BoE’s concern about the persistence of inflation; the May projection shows YoY CPI returning below the 2% inflation target in mid2025 (Chart 5). Taking into  account the ‘upward risk’ to the inflation outlook, they probably see CPI around target from mid-2025. An interesting comment from Broadbent was that profit (unlike in the EZ) had not risen as a share of national income, focusing the driver for persistent inflation squarely on wage growth.

The MPR marginally raised its expectations for service inflation in the near-term, although they noted that their previous estimates had been approximately right (Chart 6).

The tone from the MPC around inflation’s current composition was far more in line with our own view (that UK inflation will be less sticky than in Europe) than that of the market:

• services inflation has a relatively stable trajectory versus in the EZ and US (Chart 7);
• energy inflation has yet to see base effects fall away like it has elsewhere (Chart 8);
• food inflation is a big issue, although it remains below that in Europe (Chart 9);
• other goods inflation is falling, unlike in Europe (Chart 10).

So, while food inflation remains a big unknown, and continues to confound expectations (especially given surveys suggest price pressure are falling), the BoE noted that input prices have peaked, and hedging strategies may have made the decline back more prolonged.  The large drop in energy base effects should provide some relief near-term.

Looking Ahead: Data Key Room for Pause in August

The MPC explicitly provided no directional steer on policy rates. At this stage, we continue to expect Q2 to see further softening in labour market tightness, feeding through into reduced wage growth. There is probably room for another 25bp hike come June, but by the time we reach August (and a new MPR), the deceleration in inflation should allow  them to choose to pause there (Chart 11).

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

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