01 August 2022 Europe | Monetary Policy & Inflation | Politics & Geopolitics

BoE Preview: 50bp With a Dovish Outlook

By Henry Occleston
4 min read

Summary

The MPC will likely hike bank rate by 50bps to 1.75% on 4 August to combat the worst inflation the UK has seen in 40 years.
A smaller 25bp is possible, though, and we expect a decidedly dovish tone around more hikes.
Expect more info on the process of the BoE selling its government bond holdings (due to start in September). We expect them to lean on this quantitative tightening more than hiking to tighten policy.
The updated MPR will likely show a weaker growth outlook and a further rise in peak CPI given Ofgem price cap rises. But medium term, inflation forecasts should show an undershoot.

50bp Now, Less Later

A 50bp hike in bank rate is on the table for the Bank of England’s (BoE) Monetary Policy Committee (MPC) meeting on 4 August. That is the clear tone of recent comments from MPC members. The move would be the biggest rate increase for 27 years. But given the current inflation climate, and the need to get to neutral rate, this looks credible (Chart 1). However, beyond that, we expect the ultimate amount of hiking to disappoint markets.

Our rationale is as follows. This will be arch-hawk Michael Saunders’ last MPC meeting. Business and consumer surveys continue to deteriorate, which will only worsen as enormous energy price rises in October crush households. Alongside rate hikes, active quantitative tightening (QT) is set to begin in September. The BoE should be cautious in pulling too many levers at once. Our long-held view is for them to prioritise households over the market and lean more on QT than hikes.

Could the BoE Turn More Hawkish?

There are, however, several reasons the market may consider a 50bp hike as evidence the BoE is turning more hawkish. But none are currently strong enough to dissuade me from my view.

Firstly, near-term inflation within the Monetary Policy Review will likely be revised significantly higher. The Ofgem energy price cap rise for October (tba early August) will need to rise much more than previously assumed. However, this is not actually a hawkish outcome. A 50% (or more) rise in energy bills is completely beyond the scope of the BoE. And it would be unlikely to raise the medium-term inflation outlook. It will instead put even greater strain on households and incentivise a further shift away from real consumption.

Why would the BoE move at a record clip (50bp) only to pause straight after? BoE hawks have consistently argued that more now means less later. Front(ish)-loading hikes is therefore reasonable. The ECB only last week said the increased pace does not change their ultimate target. Meanwhile, an opportunity to pause to assess the effect of the larger move when they are about to enter active QT would also make sense.

The MPR: Near-Term Inflation Spike, Medium-Term Undershoot

The meeting will see the MPR updated and with it the BoE’s forecasts for major economic data. It will reveal the expected effect of announced government household support measures. The inflation forecast will likely be of most interest (unemployment will still be forecast to remain low, while economic output will likely be revised down).

The May MPR forecast CPI to peak in Q4, and this will likely remain unchanged (Chart 2). Since then, BoE speakers have warned the peak would need to be revised higher, but the rise could be greater than they thought. Ofgem’s CEO suggested the energy price cap would need to rise 42% in October based on price data from late May. The price has more than doubled since (Chart 3).

An offset may come via an energy VAT or fuel duty cut by the new prime minister. But BoE expectations will not likely include this until it becomes policy. Meanwhile, the price spike will further crush consumer sentiment and with it economic growth.

Further out, the medium-term headline inflation forecast (predicated on market pricing for rates) is likely to undershoot the target even more than previously. In May, Q2 25 CPI was forecast at 1.45% based on bank rate peaking at 2.6%, while with a flat 1% bank rate, CPI ended at 2.32%. Now, the forecasts will need to account for growing headwinds to underlying demand, and higher assumed rates. For the market-based forecast, this will amount to 40bp of additional tightening, while the ‘unchanged-rates’ forecast will need to account for up to 50-75bp. The risk is consequently high for the inflation forecasts to soon indicate no more hikes needed.

Bottom Line

Alongside QT, a 50bp hike at the 4 August meeting would mark a considerable shift away from over a decade of easy money since the Global Financial Crisis. That said, with the UK economy teetering on recession, we expect the BoE will temper expectations for further rate hikes at the meeting.

The results for markets could be multi-fold. A more bearish outlook for the economy would likely weigh on UK risk sentiment and, with it, the pound. That would leave UK equities looking comparatively vulnerable (see John’s view on the US vs UK/Europe equities). For bonds, the more risk-off tone, and the prospect of fewer future hikes should allow yields to fall. However, the offset will be the BoE’s move into active gilt sales, and the likelihood that the next UK PM will run an increased fiscal deficit.