The Bank of England today shocked markets by voting 7-2 to hold rates at 0.1% while voting 6-3 to maintain the current stock of assets at £875bn. While we largely expected the Bank to hit back against aggressive market pricing of rate hikes by holding rates, we anticipated a tighter split in the vote in order to signal to markets that tighter policy was imminent at December’s meeting.
The more decisive voting split came as a dovish shock, sending front-end Gilt yields lower along with the pound.
The dovish impact was compounded by the Bank of England’s inflation forecasts, which are conditioned on the market implied rate path, that further confirmed the view that policy will take a more prudent path than money markets currently expect – inflation is expected to fall below the 2% target in 3-years’ time should the Bank rate rise to 1%.
Given today’s announcement, and the repeated emphasis on the progress of the labour market, we expect the Bank to hike rates by 15bps at December’s meeting should the Furlough expiry have a limited impact on the labour market.
The dovish push back in the voting split today suggests the risk of a more hawkish rate hike in December, of around 25bps, is substantially lower than before the meeting. Our view on UK rates is swiftly becoming the market consensus when looking at December 2021 short sterling futures.
GBPUSD falls over a percentage point following a dovish BoE rate decision
Post-press conference: Implicit 1% ceiling to the Bank Rate outlined by the MPC
Governor Bailey continued the cautious tone outlined in the rate statement in the press conference today, highlighting the risk of tightening interest rates too aggressively such that spare capacity opens up towards the end of their forecast horizon. By doing so, the Bank has effectively implied to markets that a Bank Rate of 1% is the ceiling under the current economic assessment. This ceiling is unlikely to be hit unless there is a significant de-anchoring of medium-term inflation expectations, which isn’t the case at present; both 2-3 year and 5-10 year inflation expectations remain below 2010-19 averages when looking at the Bank/ Kantar measure.
This implicit ceiling to rates, coupled with the Bank’s concerns over labour market developments post Furlough, suggests to us that rates will likely be raised throughout 2022 but in a more conservative manner.
Compounding our expectation of a 15bp rise in December, we anticipate the BoE will raise rates again at February’s meeting such that the Bank Rate hits 0.5% and the reinvestment stage for QE ends, with another 25bps hike in H2 2022.
In the FX space, while the BoE decision has weighed on the pound today, we expect the initial reaction to be reversed in the coming months as policy turns more hawkish, albeit not as hawkish as pre-November market pricing suggested. Relative to other G10 central banks, our expectation for UK rates leaves the BoE on the hawkish side of the spectrum. This should result in front-end rate spreads remaining supportive for a GBPUSD rally, especially once the Bank Rate starts to move. However, the ceiling to the UK 2-year Gilt curve given the speedbumps to the Bank Rate in the near-term suggests that GBPUSD will struggle climbing substantially above the 1.40 handle in the medium-term without a material upgrade to the Bank’s economic outlook.
Short sterling futures begin to fall in line with our BoE rate expectations with Dec 21 implying a Bank Rate of 0.5%, with Dec 2022 moving towards a 1% terminal rate
Author: Simon Harvey, Senior FX Market Analyst