BoE Preview: 25bp Hike, But Dovish Details Could Mean GBP Weakness

Summary

• We expect the BoE to hike by 25bp this week, although the statement and forecasts will be important to watch for dovish signs.
• The vote pattern will likely be 7:2 in favour of a hike, while the forecasts will need updating to reflect a more hawkish near-term GDP and inflation outlook.
• The BoE will struggle to pause until inflation properly slips and labour market weakness kicks in. We expect that later in Q2, leaving a good chance for June to be the final hike.

Market Implications

• The market is probably under-pricing the prospects for BoE cuts to begin before the end of the year.
• If the BoE indicates a possible pause in the next few meetings, expect weaker GBP. We would play this vs CHF or USD.

Current BoE Forecasts

Link to Most Recent BoE Meeting Minutes

BoE to Hike, But Details May Be Dovish

While we have previously been very dovish on the BoE, the recent data outturns have led us to shift our expectations toward further hikes. And while the likely 25bp remains important at the May meeting, we will also see the updating of the monetary policy report (MPR) and with it the Bank’s forecasts.

At this stage, it seems likely that this will mean an upward revision to the near-term GDP and CPI forecasts (Charts 1 and 2). Further out, inflation will likely continue to undershoot the target, but potentially by less. Expectations around the labour market will be important.

While wage outturns have been consistently stronger than expected, Chief Economist Pill has noted its momentum is slowing, and there are nascent signs of labour market loosening. Watch whether the BoE reads further into this.

Wage growth has been a thorn in the side of MPC policymakers, not only for overshooting versus forecasts but also inviting PR gaffs in comments. The latest came via Chief Economist Pill, who (despite) explicitly blamed persistent inflation on both employers and employees (although the papers have jumped on the latter).

The ECB has, by contrast, for some months been discussing the role of rising corporate profits in driving inflation. This week’s BoE meeting could provide an opportunity to put more emphasis on the subject, letting them shift away from the sensitive subject of real wage decline. Such comments could, however, be taken as a dovish signal that they can live with the current high nominal wage growth.

Economic forecasts will need to be hawkishly revised. However, given the weakening in the labour markets, I expect the hike will come alongside some more dovish commentary. At this stage, I expect this will set the stage for the BoE to hike now and again in June, but be able to pause thereafter.

Meanwhile, I expect the voting pattern will match the previous meeting (7:2) in favour of the 25bp hike. However, given we have not heard from her in a while, Member Dhingra could back the majority given the recent data prints.

Watch for Signs the Market Is Too Hawkish

The market is pricing a peak rate just shy of 5%. While the tone out of this upcoming meeting could greatly change our view, we currently think the market is overpricing future hikes.

We expect that the labour market will continue to loosen and inflation (particularly food) will see strong near-term deceleration. That would set the stage for bank rate to peak in June at 4.75% and open the possibility for BoE rate cuts before the end of the year. So, unless the BoE clearly indicates they will continue to hike into such a situation, we would see room for paring current market pricing (Chart 3).

Potential to Position for GBP Weakness

Since the beginning of the global hiking cycle in 2021/22, interest rate differential has been a strong driver of GBP performance. In the last few months, this has seen the currency benefit strongly – particularly versus EUR and USD on the back of comparatively hawkish BoE pricing vs other major central banks (Chart 4). If the BoE does indicate a pause before the market is pricing, we would expect GBP weakness. Richard has recently written on the possibility for strength in CHF and, in the short term, consolidation in USD. There could therefore be good value in trading both these views by being short GBP/USD or GBP/CHF.

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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.)