BoE React: Pushing Back on Terminal Rate

Summary

• The Bank of England hiked 75bp and pushed back on terminal rate, as we had expected.
• Updated forecasts are strongly dovish. They do not take into account a likely tighter fiscal policy path after the 17 November fiscal plan.

Market Implications

• We reiterate our view that there is value positioning for a lower BoE terminal rate, alongside gilts curve steepening.

75bp But a Pushback on Terminal Rate

As we had expected, the BoE hiked 75bp, but pushed back on the terminal rate (which is what drives mortgage rate). Governor Bailey explicitly related to the fact that mortgage rates were too high. The most important part of their statement read:

‘The majority of the Committee judges that, should the economy evolve broadly in line with the latest Monetary Policy Report projections, further increases in Bank Rate may be required for a sustainable return of inflation to target, albeit to a peak lower than priced into financial markets.’

This is the kind of stark move into tempering market expectations that we had been looking for. However, while GBP sold off on the back of the announcement, rates markets had more trouble pricing just how much of a pushback this was. This may be due to the fact that the BoE’s monetary policy report (MPR) defines the ‘market priced’ peak to be the 5.25% 7D average from end-October, while as of this morning actual pricing was just over 4.8%.

The presser provided little clarification, with Bailey and other members of the MPC. seeming keen to state that the comment referred to the 5.25% in the MPR, but then (realising how un-informative this made the statement), stopped short of saying as much explicitly. They were similarly evasive around observations that the two MPR paths (one with rates at a stable 3%, the other rising to 5.25%) suggested rates closer to the former than latter.

Despite these idiosyncrasies, the most important take away from the announcement should be that MPC members are now explicitly looking to temper market pricing, even while conceding that their forecasts do not include what will likely be a disinflationary fiscal announcement in two weeks.

The voter pattern was also dovish. We had warned of a 100bp risk on the back of the need to offset the energy price cap’s support to consumers. Instead, we got dissenting votes for 25bp and 50bp from external members Dhingra and Tenreyro respectively. This suggests that come December there’s a high chance these two members vote for no hike, while the bulk of voters shift towards a deceleration in the pace of tightening.

CPI Forecast Hawkish Near-term, Dovish Further Out

The BoE’s baseline forecasts (based on market pricing) were unsurprisingly bearish on the economy, and the medium-term inflation outlook. It is interesting though to note that their inflation forecasts (both with bank rate flat at 3%, and with bank rate rising to 5.25%) have a relatively well-supported near-term trajectory (Chart 1). Even taking a hawkish outlook (whereby full two-thirds of the weighted categories retain strong inflation trajectories out to the end of 2024), the near-term profile of the YoY inflation rate would undershoot BoE forecasts. This is largely due to the MPC looking for 10.9% YoY in October; a far larger rise than the October energy price cap would suggest. Consequently, the risk is also looking like the BoE’s forecasts may be undershot relatively soon.

Further out, the rise in inflation they expect into 2025 is assumably on account of the fiscal policy support (Table 1). Tax hikes and real public sector and benefit pay cuts at the 17 November fiscal plan will likely offset a large chunk of this, meaning a more dovish picture come December.

FX Takes Stock, Rates Do Not

On the day, the MPC’s paring of hike expectations and more bearish outlook saw GBP drop back (Chart 2). This was no doubt supported by the rebuffing of dovish pivots at both the Fed and ECB meetings.

However, in the rates world, the market response was far more muted. Pricing for terminal bank rate was almost completely unchanged on the day (Chart 3). Meanwhile, although gilts steepened (in line with our PCA model and our fundamental view), the short-end still saw modest selling (likely a feed through from EGBs and USTs). The larger reaction may be seen in this regard following the 17 November fiscal plan, when the fiscal policy stance will be made clear, and a reduction in short-end gilt issuance will likely be announced.

We reiterate our previous view that there is value in receive Q1 2023-expiring GBP swaps and positioning for curve steepening (2s10s or 5s10s).

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.)