BoE to Stand Pat, UK CPI to Continue Normalisation

Summary

• We expect no change in policy at the BoE’s meeting this week, with two voters likely to vote for a cut but the rest to back a pause.
• Tone could be dictated by the CPI print, which we expect to show inflation ticking back towards MPR forecasts. Our estimate is slightly higher than consensus in headline and services, but slightly lower in core.
• The most important parts will be wage-intensive services inflation, which we expect to show more normal rates after strong March/April data driven by the minimum wage rise.
• We see data and surveys indicating near-term loosening. If inflation comes out as we expect, this should allow an August cut and at least one more before year-end.

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 Unlikely to Cut Just Yet

We expect the BoE will lack the ammo to cut rates at this meeting. Currently, little reason exists to expect a change in the voting pattern from last time at 7:2, with Ramsden and Dhingra backing a cut. It will be Broadbent’s final meeting (to be replaced by Lombardelli on 30 June).

Comments will probably still relate to the loosening labour market – that progress is being made towards the target (due to the restrictive stance), but that more progress is needed. There are two good reasons:

• The data (inflation in particular) has not given them the headroom to cut – given it is overshooting their forecasts, particularly in services (partly on the rise in financial services).
• The MPC decision to make no policy-related speeches until after the general election on 4 July limits guidance.

We think the BoE are keen to cut but that, when they do so, they will want to caveat the move strongly and carefully to ensure market pricing does not shift overly dovish (as per comments that policy remains tight even after a cut). They may have a hard time achieving this without making speeches.

In our view, UK surveys and data suggest room for near-term loosening. The BoE’s issue will be the messaging around that. If inflation drops back towards their MPR forecasts ahead, a cut in August and at least another before year-end are likely.

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.

May Inflation Could Drive the Tone

The May inflation data released the day before the BoE meeting could influence the statement’s tone. Broadly, it is expected to show a tick back towards BoE forecasts.

Our bottom-up model is tentatively more hawkish than the market in headline and services inflation, but marginally more dovish on core inflation (Table 1). This divergence is explained by our hawkishness on rental inflation (which we consider a consequence of monetary policy transmission).

The important sectors to watch remain the wage-intensive services inflation (Chart 1). There, the recent acceleration in catering and accommodation prices is a concern (Chart 2). We currently think the March and April acceleration was due to frontloaded minimum wage rises in those sectors rather than a sign of momentum building.

If the wage effect is indeed the driver, it would suggest:

• Momentum in wage-intensive services inflation will slow again (a dovish development).
• The recent rise will however not be reversed in May, so YoY inflation will slightly overshoot BoE estimates ahead.

Surveys and Data Support Near-Term Easing

Financial conditions continue to tighten. This is one rationale for the BoE to loosen sooner rather than later, and they have commented as much. Market-based financial conditions appear to be continuing to tighten (Chart 3). Further to the market tightening, real-bank rate is rising as inflation falls, and the elevation in 5Y swap rate (and with it mortgage rate) means there is still tightening passing through (Charts 7 and 8).

Inflation expectations continue to look well anchored, which offers the BoE comfort they are not feeding into elevated wage rise requests (Chart 4).

Wage rises continue to overshoot BoE expectations (Chart 5). However, their composition is less concerning given consumer-facing services job wage growth seems to be stabilizing. Similarly, evidence of continued labour market loosening should offer comfort (Chart 6). The extent is uncertain while ONS LFS data is unreliable.

Surveys on economic performance are mixed but look to be improving (Chart 7). Consumer confidence is rebounding, and Lloyds Business Barometer is at multi-year-highs. Meanwhile, hard GDP data suggests stagnation in April (after a strong March), and manufacturer order books remain weak.

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.)