Surprise hawkish shift from Bank of England

They may have left policy unchanged, but with Kristin Forbes voting for a hike and the tone of the minutes signalling others may soon join her, the BoE are clearly signalling where they think the balance of risks lie.

The Bank of England has left monetary policy unchanged as widely anticipated. Bank Rate stays at 0.25% and the Asset Purchase Facility is maintained at £435bn. However, there was a surprise in that Kristin Forbes voted for an interest rate rise to 0.50% on the basis that inflation ”was rising quickly and was likely to remain above target for at least three years”, while “the weakness in activity expected since the referendum had not materialised”.

She might be joined by a couple of others soon given comments within the meeting minutes. “With inflation rising sharply, and only mixed evidence on slowing activity domestically, some members noted that would take relatively little further upside news on the prospects for activity or inflation for them to consider that a more immediate reduction in policy support might be warranted”.

“At present, the Committee’s best collective view is that the central judgements underpinning the February projections remain broadly on track, and so the conditioning assumption underpinning the February projections – that there will be some modest withdrawal of monetary stimulus over the course of the forecast period – remains appropriate.”

Despite this hawkish tone, financial markets have their doubts that enough MPC members will back the idea of tighter monetary policy soon. Using the OIS curve they are pricing in a 25% probability of a 25bp rate rise by the end of 2017 and a 60% chance we will see a 25bp rate rise by the December 2018 MPC meeting. We don’t disagree with that assessment.

While inflation is likely to surge above 3% later this year on sterling related import costs, we think that the uncertainty over the growth outlook (read downside risk) is too great to justify action until there is real clarity on the likely Brexit deal.

Our concern is that the political calendar in Europe and the rise of anti-establishment parties means EU negotiators will take a tough line on Brexit to deter other countries from following the UK’s path out of the EU. Unfortunately, this means little headway being made in the next twelve months.

Worries about the prospects for a “positive” deal will act as a brake on UK economic activity, which is already feeling the effects of squeezed spending power, and this should dampen medium term inflation pressures. In this regard we can point to 2008 and 2011, when inflation rose above 5% and the BoE “looked through” the temporary move, to support our forecast for stable policy through to 2019.

James Knightley
Senior Economist, UK, US, $ Bloc
T: +44 20 7767 6614



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