UK Reaction: BoE hikes, but more cautious on future hikes than Fed

• BoE hiked Bank Rate by 0.25% to 0.75% today - its third successive hike for the first time since 2004.
• The MPC voted 8-1 for the rise, with one member, Cunliffe voting to leave rates unchanged – a significant swing from last month when four members voted for a 50bps hike.
• The Committee guided that “further modest tightening … might be appropriate in the coming months” – a change from last month’s assessment that this was “likely”.
• Minutes suggested that the BoE envisioned February’s outlook – a slowdown in activity and a rise in unemployment – to be exacerbated by current conditions.
• The MPC appeared more focused on the scope for a marked slowdown in activity over the coming years, than on concerns over inflation expectations, which it considered “well anchored”.
• Next week’s Spring Statement will be important to this outlook as well as further developments in Ukraine.
• We forecast further rate hikes in May and June (to 1.25%), but the MPC to leave rates at this level, with consideration of an easing in policy to rise in 2023. 

The Bank of England (BoE) fulfilled ours and market expectations for a 0.25% rate hike in Bank rate to 0.75%. This was the third consecutive hike from the BoE – the first time it has tightened as consecutively since 2004. However, where in February the 5-4 split on the Monetary Policy Committee (MPC), with 4 voting for a 50bps increase, had spooked the market and led to a further expectation of rate hikes, this time the Committee voted 8-1, with John Cunliffe’s dissent being in favour of leaving rates unchanged. As with February, the debate was likely on the pace, rather than extent of rate hikes, with Cunliffe arguing that a “fuller assessment” was needed – probably arguing for a hike at the next meeting instead. Nevertheless, the split indicates a more cautious interest rate outlook, with the Committee now stating that “further modest tightening monetary policy might be appropriate in the coming months”, compared to an assessment that this was “likely” to be appropriate in February. 

The Bank acknowledged that Russia’s invasion of Ukraine added uncertainty to the outlook, but would likely raise inflation in the near term and weaken activity. It also condemned “Russia’s unprovoked invasion”. However, its assessment this month built on the theme developed in the February Monetary Policy Report before the invasion: with inflation likely to rise in the short-term, a material squeeze in real incomes would likely lead to subdued activity over the medium-term, opening up a degree of spare capacity and leading to a significant “decline in pressure on domestically generated inflation”. The BoE had forecast that unemployment would rise to 5% in February and inflation fall below target. The BoE explained that this would be further exacerbated by the Russian invasion, as well as by the increase in implied rate hikes relative to February.  

In contrast to the Federal Reserve yesterday, the BoE appeared relatively more confident that the current series of supply shocks will not culminate to a dislodging of inflation expectations and continues to allow the Committee to ‘look through’ the current shock to anticipate the slowing of economic activity and material drop in inflation likely to come over the rest of the forecast horizon. Indeed, the BoE stated that “Overall the MPC judged that inflation expectations remained well anchored at present”. The BoE also reiterated that its framework allowed for a departure in headline inflation from target as a result of shocks and distortions – and that the invasion was another such shock. For now, the Committee appears to be considering the real prospect of a material slowdown in the UK economy as the real income squeeze bites, contributing to a material fall in inflation below target. 

A number of factors could change this. Developments in the Ukraine invasion remain difficult to predict and could impact the outlook materially. The MPC also noted that the ONS is yet to clarify the impact of the government’s Energy Bills Rebate. Moreover, the Chancellor’s Spring Statement next Wednesday could see much more fiscal support for households. Finally, we would argue that at present the BoE downplayed the “somewhat” stronger GDP growth recorded in January and appeared to place little weight on labour market developments that had also been firmer than in February. This could change if it persists into May’s forecast round.  

May’s Monetary Policy Report will be an important exercise in terms of forming the BoE’s rate outlook. At this stage, we expect to see a marked drop in GDP and inflation through 2023 and 2024, with unemployment materially higher (based on current implied market rates). We expect some members of the MPC to place some weight on the risk of inflation expectation continuing to rise and inflation persistence rising. As such, we expect the MPC to raise rates again in May (to 1.00%) and June (to 1.25%) - although we concede that the BoE could pause in June to deliver a more considered increase in August. We think that this will mark the high in Bank Rate for this year. Moreover, with growth expected to be below trend in 2023 and 2024, unemployment expected to rise and inflation expected to be falling materially, we think the debate will shift to the prospect of rate cuts in 2023. On balance, we hope to see an easing of the terms of trade shock in 2023 provide some relief to the UK outlook and the BoE to leave rates at 1.25% with a view to reinforcing inflation expectations discipline, but this is likely to be dependent on the ultimate scale of impact that Russia/Ukraine, and other shocks, deliver. Moreover, we note that there was no mention of the consideration of active balance sheet unwind in today’s minutes, which is scheduled at some point after Bank Rate reaches 1.00%. It is our view that the BoE will not proceed quickly with these considerations. 

Markets acknowledged this more cautious stance from the BoE. Short-term rate expectations shaved nearly one full rate hike off end-year levels compared to pre-meeting. 2-year gilt yields were 14bps lower at 1.30%. 10-year yields also fell by 10bps, before retracing the drops to be down just 4bps at 1.58%. Sterling also fell back by 0.8% to both the US dollar and the Euro, at $1.3107 and £0.844. Stocks gained, wit the FTSE 100 up 0.3%.