BoE Preview: 25bp Hike With a Risk of Hawkish Skew

Summary

• My base case is for the MPC to hike the bank rate by 25bps to 1.25%. Hawkish dissent seems likely, and while the risk of a 50bp hike is low, it is not zero.
• Labour market tightness and rising wage growth continue to drive the need for tighter monetary policy.
• The hawkish skew may come on the back of falling public satisfaction with the BoE and looser HMT spending (which will dampen the cost-of-living crisis).

Market Implications

• The market is already pricing in a very aggressive BoE profile. A hawkish surprise could see it move further. I would see value in fading such a move.
• Further out, I expect the BoE will prioritise UK households over market participants in its path for tightening. This means heavier gilt sales and fewer hikes than the market expects.

A Hawkish Lean Likely

The BoE struck a careful balance at their last meeting on 5 May, with hawkish voter dissent coming alongside a dovish twist in comments. Three voters backed a 50bp hike (more than I had expected at the time), but two also noted there was now no need to continue hiking.

I have considered the market too hawkish in pricing the BoE terminal rate for some time. However, in the near term, the case is building for them to tack hawkish in tone and action. Wages continue to grow at elevated rates on account of the ultra-tight labour market, showing the building second-round effects (Chart 1).

Despite the growth in wages, households are still being squeezed (Chart 2). Meanwhile, public surveys are showing record dissatisfaction at the 9% inflation rate – and the BoE more generally (Chart 3). Raising the bank rate has previously been criticised as adding further pressure to households. However, the Chancellor’s recent measures to dampen the cost-of-living crisis (including a £400 discount on energy for all and a £650 payment to eight million households) should offset this somewhat, providing extra room for policy tightening.

While the doves have not capitulated completely, the tone from the likes of Silvana Tenreyro appears to have softened. It seems likely, in the face of 50bp dissent, that she and Jon Cunliffe will vote for 25bp, rather than no change, as they alluded at the last meeting. Meanwhile, the hawks continue to push for a frontloading of hikes. It seems plausible that Michael Saunders, Jonathan Haskel and Catherine Mann will vote for a 50bp hike again. And there may be room for Dave Ramsden to join them. That could leave the balance of voting between 25bp and 50bp very tight.

While the outcomes may be quite binary, there is a strong risk for a hawkish skew in tone and voting pattern. The market is currently pricing quite a lot into the profile further out – up to a peak of around 3.4% in 12 months’ time. It seems unlikely that they will be able to deliver all of this. However, a hawkish surprise could be enough to send the profile even more aggressive. In such an instance, we would see good value fading the initial hawkish jump.

Future Gilt Sales to Sustain Gilt Curve Steepening

On the asset sales side, little is expected until the telegraphed update in August (alongside an updated MPR). I still think that when it comes to that point, the BoE will choose to lean more on QT and less on hikes than the market is currently pricing.

This remains my view for several reasons, including:

• Rising rates adds further pressure to households squeezed by rising energy prices. While the attractiveness of tightening via the bank rate is higher than it was before the Chancellor’s spending package, their capacity to hike to market implied levels is limited.
• While financial conditions have been hit recently, financial institutions remain resilient. Credit spreads have widened, but they remain within the mid-to-lower end of historic ranges (Chart 5).

In short, the BoE will prioritise UK consumers over market participants in its path for tightening.