BoE Review: Hawkish Forecasts, Dovish Tone; A Hard Sell

Summary

• The BoE hiked 25bp as expected and hawkishly revised their forecasts – in line with broad expectations.
• As we had expected, the presser aimed to tack a dovish tone to caveat the apparent hawkishness of the forecast revisions.
• However, press conference attendees (and the market) doubt the dovishness.

Market Implications

• The release does not change our expectation that the BoE will hike once more in June and pause in August.

BoE Hikes With Hawkish Forecasts, But Comparatively Dovish Tone

Last week, the Bank of England (BoE) voted 7:2 to hike 25bp, as expected. Meanwhile, they shifted their forecasts materially more positive/hawkish to account for data and policy since the last Monetary Policy Report (MPR). Governor Andrew Bailey and Deputy Governors Ben Broadbent and Dave Ramsden were on the backfoot throughout the press conference, with their credibility and track record under attack.

Overall, the meeting changed our perception of the BoE little: they are keen to pause, but recent data has stopped them. Despite their hawkish GDP forecast revisions, their focus remains services inflation, wage growth and labour market tightness. This week’s data supports our core view that the UK labour market is loosening faster than the BoE assumed, but wage growth remains strong. We still think they will hike again in June and pause in August, opening up possible cuts towards year-end.

GDP: Revised Higher, But Still Weak

The GDP profile was revised to be roughly flat YoY for the first two quarters of the year before rising higher and sooner than in the February MPR (Chart 1). This morning’s Q1 GDP numbers have already proven slightly stronger than this, although the sharp deceleration in March is worth noting.

This MPR provided the largest upward revision in Monetary Policy Committee (MPC) history. Despite this, Bailey was careful to note that GDP growth remains low versus the historic trend and is largely related to lower gas prices, positive global developments (EZ and China in particular), and support from the Spring Budget. The risks to the forecasts were deemed balanced, and Bailey noted that only a small proportion of the previous rate hikes had fed into the mortgage market (c.70bp out of 300bp in mortgage rate rise).

The Labour Market: A Slower Loosening, But Focus on Wages

Bailey conceded that while the labour market had loosened, it had done so by less than previously expected. Meanwhile, the unemployment rate is now expected to remain near recent lows into 2024 (Chart 2). That is despite survey data on hiring continuing to ease. This puts the MPR’s forecasts for unemployment at a very shallow rate historically. If the labour market continues to loosen as we predict, there is strong room for an upside miss through Q2.

For now, the BoE are more concerned about wage growth. They expect private pay growth to decelerate through the remainder of the year. This would constitute only a slight slowing of recent trajectory, but recent wage growth momentum suggests an upside risk to this view (Chart 4).

In his remarks, Bailey noted that (at the time of the MPR) wage growth had tracked roughly in line with their February expectations. Meanwhile, Broadbent added that the drivers of wage growth have been mostly the cost-of-living squeeze rather than unemployment. The BoE reported signs that this squeeze is starting to fade. Together, this was another relatively dovish appraisal.

Inflation: Raised Across the Horizon, But Base Effects Important

The new profile across the projection horizon reflects the BoE’s concern about the persistence of inflation; the May projection shows YoY CPI returning below the 2% inflation target in mid-2025 (Chart 5). Considering the ‘upward risk’ to the inflation outlook, they probably see CPI around target from mid-2025. Broadbent said profit (unlike in the EZ) had not risen as a share of national income, focusing the driver for persistent inflation squarely on wage growth.

The MPR marginally raised its expectations for service inflation in the near term, although they noted that the previous estimates had been approximately right (Chart 6).

The tone from the MPC around inflation’s current composition aligned more with our view (that UK inflation will be less sticky than in Europe) than the market’s:

• Services inflation has a relatively stable trajectory versus in the EZ and US (Chart 7).
• Energy inflation has yet to see base effects fall away like it has elsewhere (Chart 8).
• Food inflation is a big issue, although it remains below that in Europe (Chart 9).
• Other goods inflation is falling, unlike in Europe (Chart 10).

Food inflation remains a big unknown and continues to confound expectations (especially given surveys suggest price pressure are falling). But the BoE noted that input prices have peaked, and hedging strategies may have prolonged the decline back. The large drop in energy base effects should provide near-term relief.

Looking Ahead: Data Key, Room for Pause in August

The MPC explicitly provided no directional steer on policy rates. We still expect further labour market loosening in Q2, which should eventually reduce wage growth. There is probably room for another 25bp hike come June, but by August (and a new MPR), the deceleration in inflation should allow them to pause (Chart 11).

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

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