BoE Preview: On Your Hike!

Go to: Stress, Surveys and Data

Summary

• We expect the BoE to hike by 25bp to 4.75% this week. There is a high risk of votes for no change, and a risk of a vote for 50bp too. Commentary will be watched closely to determine whether now is the time to fade hawkishness.
• On this front, we expect a hawkish lean in commentary. The market may not yet believe dovishness, but the underlying data continues to suggest the hawkishness is overdone.

Market Implications

• Stand ready to fade BoE hawkishness. It may not come this week via the inflation data and BoE statement, but ultimately a weaker GBP and lower terminal rate are likely.

Current BoE Forecasts

Link to Most Recent BoE Meeting Minutes

BoE(ing) Under Pressure

The Bank of England (BoE)’s Monetary Policy Committee (MPC) is under fire from all sides. Some of this criticism is just misfortune, such as the surprising jump in labour market and  inflation data. However, the BoE has also made self-inflicted errors, such as the stubborn refusal to tackle profit growth, alongside many other communication errors. So, while the market will be watching carefully for indications of their plans ahead, if the MPC comes out less hawkish than the market is pricing, it is likely to be met with scepticism.

We expect the recent spate of data will lead the MPC to vote to hike a further 25bp and signal that more will be done until inflation has been tamed. Arch-dove Silvana Tenreyro will most likely vote against the hike, but this does not matter given it is her last meeting as an MPC member. Swati Dhingra will probably also vote not to hike. She has previously stated that rates should peak below 4.5%, and more recently emphasised the delayed effect of hikes and the pressure already being felt by households.

However, the risk at this stage is that the market will price in more hawkishness. The market is now pricing more than 25bp of rate hikes for every meeting to the end of the year (Chart 1). The selling in short-end of UK rates seen on Monday is a sign that the market is unwilling to pull back. we were wary of this kind of price action when we chose to close out our long 1y1y SONIA trade in our model portfolio – we expect there to be good re-entry levels soon.

With no press conference or update to MPR forecasts, the market will have little to cling to to justify its hawkishness. What they may get (in order of likelihood and reverse order of hawkishness) is:

• An emphasis within the MPC statement that there have been upward surprises to inflation, economic activity, and wage growth since the May MPR [almost certain].
• The possibility of Catherine Mann voting for a 50bp reacceleration now [50:50].
• More explicit comment for the possibility of a future re-acceleration to 50bp hikes [40:60].

On the dovish side, there is a strong risk of emphasis on:

• The recent rise in mortgage rates weighing on households and the proportion set to re-finance in the next two years.
• The recent rise in bond yields feeding into market conditions.
• The lagged effect of past rate hikes.

The factors that are featured in the statement will determine the immediate market reaction, and whether a good entry to fade hawkishness presents itself now or later. We like to watch the pricing for December (six months), given the amount priced in for the BoE until then, but it is also worth watching pricing 12 months out in comparison –it is flat on 6mths, which seems unlikely.

Unlikely to Deliver 6% Bank Rate but Wait for Entry

The almost 6% BoE terminal rate currently priced into the market looks very extreme. Few within our network disagree, but it has been a painful view to trade.

In the near-term, an explicit BoE pushback on market pricing (the way they did following the mini-budget last year) seems unlikely. However, we will be watching for any signs that they are leaning that way, particularly with acknowledgement of the recent shift in market price and mortgage rates.

Ahead, the loss of Tenreyro at the next meeting is unlikely to be that important. Her replacement, Megan Greene, spoke before the Parliamentary Treasury Select Committee and set out a relatively vague picture of her leanings ahead. She refused to state where she would sit versus Tenreyro, but at least (after some pressing) agreed that a hike in May was the ‘right decision’. Given how on the fence she was at her testimony, we will need to hear from her after she is familiar with the internal data and models before we can decide where she sits on the hawkometer.

To us, this presents a relatively good risk-reward to fade hawkishness. However, we have been burnt before on such a trade (as it seems have many others). The risk to positioning that way would be that the BoE ends up returning to 50bp hikes at one of the remaining meetings this year However, this seems a tail risk for several reasons:

• The BoE has been hiking longer than most other CBs.
• Mortgage rates are moving higher again (mortgage rates up c.30bp this month).
• Surveys remain weak, and inflation expectations are well anchored (Appendix)
• April unemployment was in line with BoE forecasts.
• Wage growth is high, but inflation in wage-intensive sectors is falling (Chart 3)
• Government plans to cap basic food prices, could help soften wage-price spiral fears. The burden of inflation may be shifted back onto corporates.
• The BoE is unlikely to change tack significantly without a refresh of its MPR.

However, with BoE credibility in the dirt, there is a risk of them making some big commitment to buy back some good will (Chart 4). As the recent ECB policy meetings have shown – though CBs tend to foot-drag, when they pivot, they can do so aggressively.

How Strong is the Labour Market?

The Hawkish: Employment Headline and Wage Growth

Last week saw a very hawkish outturn for the UK labour market. The unemployment rate unexpectedly dropped to 3.8% (consensus was expecting a rise to 4%), rejecting the easing trend of survey recruitment difficulty (Chart 5).

It is important to be wary of single readings, especially given the effect of inactivity rates. However, employment change drove the report, which beat expectations by 100k to rise 250k (Chart 6). Meanwhile, the more timely May HMRC numbers for payrolled employees was revised 130k higher in the YoY April numbers.

Wage growth also beat expectations across both regular (+7.2% 3M/YoY) and total pay (+6.5%). Regular pay has positively surprised since November 2021. Private pay growth rose to +7.9% YoY, further diverging from survey expectations and the slowing rate that the BoE is expecting (Chart 7).

The Less Hawkish: Employment Composition, and Surveys

An important question is, where did the rise in employment come from?

A dig down into the details shows full-time employment growth continues to decline and is now roughly stable (Chart 8). Surging part-time employment has been the driving factor. Additionally, self-employment (a far more nebulous term) has seen a sharp rise. Ultimately, this suggests that:

1. The upward pressure on wages will fall away as employment is shifting to part-time work.
2. Employment can fall back quickly as part-time work tends to be more volatile.

Meanwhile, our measures of stress and surveys also paint a continued dovish picture. Financial conditions remain tight, inflation expectations continue to re-anchor, and industrial sentiment is dropping too (Appendix).

Appendix: Stress, Surveys and Economic Data

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.

Photo Credit: depositphotos.com

(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.)