Monetary Policy & Inflation | UK
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Summary
- The BoE kept rates unchanged at their February meeting, as expected.
- Also as expected, forecasts were updated to be more dovish near term, but with a higher trajectory in inflation further out.
- The more hawkish end-horizon forecast was supported by a reduced trajectory for unemployment growth.
- Governor Bailey pushed back on market pricing for cuts. BoE assumptions on the labour market look overly hawkish.
- Services inflation, wages and unemployment will remain high on the BoE’s mind.
- I continue to expect them to be able to cut in May. Next week’s unemployment figures will be key in determining whether this is feasible.
Market Implications
- We still see value being long SONIA futures, positioning for a May cut.
- Paying 2Y EUR swap against 2Y GBP looks attractive.
- In FX, we remain bearish GBP vs USD and long EUR/GBP.
BoE Pushes Back on Cuts – Labour Market Remains Key
The BoE left rates unchanged at their February meeting – in line with broad expectations. There were three dissenting votes, with Haskel and Mann voting for a hike to 5.50%, while Dhingra voted for a cut to 5.0%. This largely aligned with our expectation, although we had thought Haskel, not Greene, would shift to a pause.
The tone of the commentary was less hawkish than at the last meeting – with the outlook of inflation in the medium term more balanced (upside risk prior), although they continue to see upside risk in the near term. They also dropped references to the potential need for further tightening, shifting messaging to a question of how long before they can cut.
However, in the tone of the presser, and the medium-term forecasts, they sounded less dovish. Bailey was explicit that given current forecast assumptions, market pricing suggested an overshoot of inflation into the medium term (Chart 1).
Chart 1: orange line = headline UK CPI, blue line = core UK CPI, dotted lines = MPR quarterly projections
This does not rule out a cut. Despite the market pricing less easing than I expect near term, I am not yet changing my expectation for a May cut. The main reason is that the BoE is focused on the sticky elements of inflation to guide its monetary policy: wage growth, unemployment and services inflation.
On these:
- Wage growth is assumed to re-accelerate MoM versus the experience of the last seven months (Chart 2). Their breakdown of wage growth ahead retains a large ‘unexplained’ factor contributing to it, and a high inflation expectations component, despite inflation expectations falling quickly (Chart 3).
- Labour market data is highly uncertain until we have the updated LFS data due next week (5 February). The BoE forecasts show even less labour market loosening than they expected in November (Chart 4).
- Services inflation has been revised lower – it looks more realistic now, although the January tick-up could overshoot on base effects (Chart 5).
(Chart 2: black line = private regular average weekly earnings growth, blue dashed line = Feb MPR projection, orange dashed line = Nov MPR projection, black dashed line = trajectory if wage growth continues recent trajectory; Chart 3: blue line = market pricing for 5y5y RPI, red line = business estimate for CPI in 3Y, orange line = consumer estimate for inflation 5Y ahead.)
(Chart 4: black line = unemployment rate, grey line = claimant count, red line = experimental unemployment rate, black dashed line = Nov MPR forecast, blue line = Feb MPR forecast, orange line = Aug MPR forecast; Chart 5: black line = services inflation, orange dashed line = Nov MPR forecast, blue dashed line = Feb MPR forecast.)
BoE Hawkometer
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.)