BoE Review: A Pause With Dovish Caveats to Recent Data

Summary

• As we expected, the BoE found comfort in the May inflation outturn’s normalisation in wage-intensive services inflation momentum.
• Recent strength in services inflation was caveated as partly driven by areas that BoE policy will not affect (index-linked or regulated).
• Downside risks in inflation were mentioned (albeit with mention also of the risk that higher inflation has become ingrained).
• The minutes suggest that in addition to the two votes for cuts, some voters were shifting towards cutting now.
• We need individual MPC comments to confirm this (none before 4 July), but the mood seems to be shifting towards easing imminently.
• If we see the slowdown in wage-intensive services momentum continue in June, a cut in August is highly likely.

Market Implications

• We still see value in positioning for a more dovish BoE relative to the Fed than is being priced. As such, we continue to like selling Z4 SOFR vs buying Z4 SONIA.

BoE Getting Closer to Cutting

The BoE left rates unchanged with two votes for a cut, as expected. However, some considered the decision to keep rates on hold as ‘finely balanced’ for some. Overall, it was in line with our expectations and more dovish than the market had expected.

Pre-BoE, we argued the MPC would take the May inflation outturn as a relief given it showed the rise in momentum in sticky services sectors fading. This appears to have happened. Dovish takeaways were that the recent strength in services inflation was caveated heavily, downside risks to the inflation outlook were noted, and there were hints some of those who voted for a pause were close to shifting to a cut.

We want individual speakers to confirm such comments (although this will not come before 4 July). Overall, the comments increase our conviction that the BoE is focusing on the data details (not just the headline) and that if the slowdown in wage-intensive services continues in June, a cut in August is highly likely.

The market is now pricing 50bp of cuts for the year. We think this will be delivered, with the risk skewed towards them delivering more. We still like long Z4 SONIA vs Z4 SOFR.

Changes to the Statement

• GDP growing stronger than expected, but surveys suggest slower pace of underlying growth – MIXED
• CPI dropped close to MPR projections; inflation expectations continued to moderate – DOVISH.
• Labour market uncertain – MPC thinks it continues to loosen, but is historically tight – MIXED.
• Pay growth is easing but higher than expected in MPR – MIXED.
• Services inflation stronger than expected, but in part driven by volatile index-linked/regulated changes (i.e. sectors they cannot affect with policy) – MIXED to DOVISH, given market expectation.
• Little change in the statement on keeping rates restrictive for a long time etc. –

More Detail from the Minutes

• Pay growth is easing in line with May MPR projection for Q2.
• Some data suggesting less moderation in pay than expected in the May MPR, with contrasting outlooks from the DMP survey (higher) and KPMG/REC (lower).
• Downside core goods price inflation somewhat offset the upside in services.
• Services inflation higher than expected at 5.7% in May. But micro data suggesting that share of services’ prices that had increased continue to ease, although they remain elevated by historical standards.
• Mixed evidence on profit margins – consumer-facing services are subject to price-sensitive consumers, squeezing profit margins, but the DMP survey was more optimistic. It reported flat/declining profits for last year, with the expectation that these will be maintained/improved in the year ahead.
• Inflation expectations continue to moderate. They are now around historic averages
• Election timing was not relevant to the decision.
• As CPI and short-term inflation expectations have fallen, it was noted that inflationary dynamics could adjust as rapidly to the downside as they did to the upside. There remained a risk, however, that there has been a more enduring shift in price and wage-setting behaviour on the back of inflation.
• Some members are worried by high services inflation and wage growth, but some members were not so concerned as the minimum wage rise was probably one-off and unlikely to be repeated, and that services inflation was supported by regulated/indexed factors. For these, the decision whether to cut or not was finely balanced.

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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.

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(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.)