The Bank of England (BoE) Monetary Policy Committee (MPC) will announce its latest policy decision on Thursday. The meeting had been scheduled for September 15th, but was delayed by a week due to the Queen’s funeral for her.
There is no doubt that the MPC will raise interest rates again, but there are major uncertainties surrounding the policy decision given conflicting domestic pressures and the global rush to raise interest rates.
Ahead of the decision, the bank knows there will be a cap on retail and business energy prices, but official estimates of the cost have not been released and there is a huge range of estimates given scope for major fluctuations in gas prices.
The government will also announce a fiscal event on Friday with expectations of substantial tax cuts.
According to ING; “[This week’s] Bank of England meeting is crucial. It will tell us not only how worried policymakers are about the slide in sterling and other UK markets, but also how the government’s decision to cap household/business energy prices will translate into monetary policy.”
A small majority of economists surveyed by Bloomberg expect the BOE to raise its benchmark lending rate to a half-percentage point to 2.25%. Markets, however, are pricing in around a 70% chance of a 75 basis-point hike with some banks talking about an unprecedented 100 basis-point move.
Sterling will dip in an immediate reaction to a 50 basis-point rate hike and with an initial jump if there is a 75 basis-point hike, but with high volatility and sharp moves inevitable.
Recession Fears Still Valid
The economy has shown very clear signs of a slowdown with a notably weak retail sales report for August. The surge in energy and food prices will maintain pressures on consumer spending.
The support measures will cushion the downturn. Recession fears will, however, still lead to some calls within the BoE for monetary policy restraint.
According to Barclays; “The broadening economic slowdown is a growing challenge to any further tightening, we expect dissenting dovish voices to become louder.”
Danske Bank added; “We expect the Bank of England (BoE) to hike the Bank Rate by another 50bp at its next meeting bringing it to 2.25%. We expect 50bp as opposed to 75bp, as we are more negative on the growth outlook. Also BoE has had a tendency to surprise to the dovish side at recent meetings.”
The bank also pointed to growth fears; “BoE was the first G10 central bank to forecast a recession by Q4 2022 at its last meeting, while using a far more dovish market pricing as policy input than what is currently priced. We see this as a contributing factor to our base case as the growth outlook looks considerably worse now than back then given current market pricing.”
BoE Can’t Ignore Fiscal Largesse
The move to cap prices will have a big impact in capping the inflation rate relatively close to current levels in contrast to previous expectations of a further surge to at least 15%.
The package to cap energy prices will also have a major impact on aggregate demand and government borrowing.
ING noted that Chancellor Kwarteng will provide a substantial boost; “He has already positioned himself as going for growth and the mini-budget should provide details on the 100-billion-pound-plus energy support package plus another 30-billion-pounds-plus of tax cuts.”
A looser fiscal policy would tend to increase pressure for monetary tightening, especially with Sterling vulnerable.
Ellie Henderson, an economist with Investec, considers that it is unlikely that the BoE will criticize government policy, but there will inevitably be an impact on their policy decisions.
She added; “They will be cooling the economy at a time when the government, through its fiscal policy, is trying to stimulate demand. There is divergence in the policy path but at the end of the day the BoE is independent and their main goal is price stability.” .”
Howard Cunningham, fixed income portfolio manager at Newton Investment Management commented; “While the energy price cap will cause headline inflation to be materially lower than under prior forecasts, other expected fiscal measures should be stimulatory.”
Global Dimension Extremely Important
The BoE will inevitably have to consider international developments, especially given the impact on Sterling.
The ECB increased interest rates by 75 basis points at this month’s meeting and there are very strong expectations that the Federal Reserve will sanction at least a 75 basis-point rate hike this week.
The Swedish Riksbank also increased rates by 100 basis points to 1.75% at this week’s meeting.
Global tightening will increase pressure for the BoE to be more aggressive and a 50 basis-point rate hike would be seen as under-whelming which would tend to hurt Sterling as yield spreads move against the UK currency.
According to Samuel Tombs, chief UK economist at Pantheon Macroeconomics; “The MPC is boxed into a corner right now and must raise bank rate quickly to prevent sterling from depreciating further, and to signal to households that it is serious about tackling inflation.”
Sanjay Raja, senior economist at Deutsche Bank commented; “A steeper move would stem the pound’s slide against the US dollar and offset inflationary pressure driven by the government’s cost of living support package, shoring up the Bank’s inflation fighting credibility.”
John Hardy, head of foreign exchange strategy at Saxo Bank added; “The Bank of England has to go 75, it has to match its global peers here when we have seen cable [pound-dollar] trading at its lowest level since 1985. It would really be quite a tone deaf performance from the Bank of England if they don’t go for 75 basis points at this week’s meeting.”
Paul Hollingsworth, chief European economist at BNP Paribas added; “The arguments for a 75 basis-point move are more compelling than those for a 50 basis-point increase.”
JPMorgan sees a case for more aggressive tightening; “Opinions are evenly divided, but we see clear reasons for a larger move. It added; “A 50 basis-point hike would amount to a dovish surprise, and this would be hard to justify after a large, unfunded and not-well targeted fiscal easing, which has been accompanied by falling confidence in markets.”
Analysts at investment platform AJ Bell noted; “It remains to be seen whether the BoE will succeed in providing support for sterling with the help of a courageous rate hike and hawkish comments.”
Sterling in the Trader’s Cross-Hairs
Commerzbank expects the key element is that real rates will remain substantially in negative territory; “With an inflation rate of 10%, it makes very little difference whether the key rate is 25 bps higher or not. At 2.25% or 2.50%, it remains clearly too low to send out a clear signal that at some point real interest rates might become anything but clearly negative again.
It added; “The BoE would not just have to hike rates further, but inflation would also have to ease. But that won’t happen anytime soon.”
Saxo Bank’s Hardy added; “If the Bank of England fails to hike 75 basis points, let’s shield our eyes for what is going to happen to the pound here.”
According to Chris Weston, head of markets research at Pepperstone, there is scope for short covering; “Given the heavy trend lower in the GBP, one can easily assume that the speculative part of the market is already heavily short GBP. This should cushion the downside on a 50bp hike but see a pronounced move higher should we see a 75bp hike.”
Nordea chief analyst Jan von Gerich added; “The momentum is weak and the moves have been strong,” he said. “We should see a stabilization at some point, but it’s hard to say when that will come.”
According to Credit Suisse; “If 50 bps is what transpires, we suspect EUR/GBP 0.9000 (1.11 for GBP/EUR) and GBP/USD levels below 1.1000 could come quickly.”
It adds; “In order for GBP to rally, we would need to see the BoE use the excuse of the government’s massive fiscal easing to radically change its thus-far tepid stance and move to hikes of 75-100 bps magnitude, with a validation of the market’s terminal rate pricing in its commentary. In this scenario, we imagine GBP/USD could try to test the 1.1700 level again and EUR/GBP could slip back to 0.8500.”(1.18 for GBP/EUR).
New Member on the Committee, High Risk of Split Decision
External MPC member Saunders left the bank after the August meeting and will be replaced by Swati Dhingra, whose views on rates aren’t well known.
According to ING; “We narrowly favor 50 [basis points] hike on Thursday, taking the bank rate to 2.25 per cent, although 75 [basis points] is clearly on the table and we would expect at least a couple of policymakers to vote for it.”
ING added; “It’s even possible we get a rare three-way vote – the first since 2008 – if dovish committee member Silvana Tenreyro votes for a 25bp hike as she did in August.”
Given the high degree of uncertainty, the bank will be very reluctant to provide any forward guidance or clarity on future decisions and will have to keep options open.
Gilt Sales Could be Delayed
The BoE is planning to engage in quantitative tightening by selling bonds back to the market.
The bank expects the mix of active sales and maturing gilts to reduce its holdings by 80 billion pounds over the next 12 months with direct sales of £10bn per quarter.
Yields have, however, moved sharply higher and the government fiscal stimulus will increase gilt issuance sharply.
Investec economist Ellie Henderson noted; “Questions have been raised whether this is the opportunity moment to sell gilts back into the market.”
The latest government borrowing data recorded a record high for debt interest payments, reinforcing concerns about the impact of gilt sales.
Newton’s Cunningham added; “They could choose to delay the commencement of active selling of gilts, recognizing the additional gilt supply coming down the tracks.”
There will tend to be greater scope for rate hikes if gilt sales are limited or delayed.