BoE Review – A More Dovish Pause Than the Market is Pricing

Summary

• The BoE left Bank Rate unchanged, but the vote was close: 5 for a pause, 4 for a hike.
• We had expected a hike on the basis that the MPC would look through the drops in air travel/package holiday and accommodation inflation.
• The minutes suggest the MPC members did indeed look through these effects, with the pause instead justified by the loosening in the labour market, and downturn in growth outlook.
• Critically, the MPC appears to have done a complete about-face in its treatment of wage growth. In August they fudged their model outputs upward to better reflect ONS data – now they seem to be concluding it is the ONS data that is inaccurate.
• If this is the case (expect we will hear more on this ahead if so), then it would lay the groundwork for a very dovish November MPR. This adds to our conviction that there is room for the market to price out any more tightening and shift to pricing cuts.
• QT was set at £100bn over next 12mths – as per consensus. Active sales will be evenly divided over buckets.

Market Implications

• The BoE seems to be done with hiking. The November MPR could be the nail in the coffin. This is not yet represented in market pricing.
• We continue to like 2s10s GBP steepeners (outright and vs EUR), but will look to more explicitly flag trades to benefit from 2024 cuts in the near future

BoE Pauses, But Dovishness Goes Far Beyond That

The Bank of England (BoE) left bank rate unchanged, but the vote was close, with just five members (Bailey, Broadbent, Dhingra, Pill and Ramsden) voting for the pause, while four (Cunliffe, Greene, Haskel and Mann) voted for another 25bp hike.

Going into the meeting, the market was just less than half-way priced for a hike, and the tight vote may be one reason why the reaction has been relatively muted (that and the fact that pricing had shifted much more dovish recently). The sharp re-pricing of expectations came following the inflation print, which showed a surprise drop in headline and services inflation. While we have long been dovish the UK outlook, our opinion was that due to the one-off nature of many of the moves (air fares, package holidays, accommodation), the BoE could look through it, as such we erred towards a final hike.

BoE Looks Through Recent CPI Weakness – As We Expected

As it turned out, the MPC did indeed look through to the inflation detail, with even those voting for a pause noting it was “important not to put too much weight on a single data point” and that adjusting for this, “services inflation has been more stable at continued high rates, albeit slightly weaker than expected”. This aligned with our perception that the trend in inflation was dovish (as it had been for some time), but that we should be careful not to read too much into the miss.

Shift in Wage Growth Assumptions Have Big Dovish Implications

A more bearish growth outlook helped the doves, but the big shift in sentiment appears to have been a change in perception on wage growth: from skewing their models to mirror higher ONS reported wage growth, to concluding that the ONS numbers are not the best representation.

At the last MPR in August the BoE basically admitted that its models could not reproduce the kind of average weekly earnings (AWE) growth that the ONS published, and had resorted to sticking a wedge on the upper-bounds of their models and taking that as a forecast. We have noted previously the strangeness of ONS wage growth being supported by employment composition, which looked at odds with other data (we contacted the ONS over a month ago on this, but have had no reply…)

We warned at the time of the MPR that the lack of fundamental rationale behind the BoE’s updated, higher wage forecasts (which “materially” pushed up their medium-term modal CPI forecast) could be revised back down rapidly if the ONS data did eventually start to turn/be corrected.

Instead, the MPC looks to be turning away from the data altogether, noting in the statement that “the recent acceleration in the AWE [are] not apparent in other measures of wages” and that the ONS’s AWE data is “hard to reconcile with other pay indicators”. That sounds a lot like they will be taking other wage indicators (such as HMRC’s PAYE data), or the DMP survey as more accurate depictions of wage growth (Charts 1 & 2). If this is the case, this would lay the groundworks for a significantly more dovish inflation outlook at the November MPR – one that likely sees inflation undershoot target into the medium-term even more (Chart 3).

Terminal Rate Can be Pared and Cuts Priced

The market is still pricing the best part of 20bp of hikes out to January 2024, and by June 2024 it prices easing only sufficient to undo this additional tightening (a net-flat profile). In our opinion, if the MPR does come to reflect lower wage growth alongside a much weaker labour market (as it will need to), the window to hiking has already closed. Instead, given the direction of the economy, cuts beginning in H1 are looking increasingly likely (Chart 4)

There is strong room for cuts to be priced into the curve. On this basis, we continue to like 2s10s GBP steepeners (outright and vs EUR), but will look for a more explicit trades to reflect UK recession and 2024 cuts in the near future.

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

(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.)