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The Bank of England has held the Bank Rate at 5.25% for the second consecutive meeting, in line with market consensus and our own pre-announcement call.
The 6-3 majority voting in favour of the decision was a marginal increase relative to the September 5-4 split, but this shouldn’t be seen as a dovish development given the change in the composition of the MPC – Jon Cunliffe who last voted to hike Bank Rate has been replaced with newcomer Sarah Breeden. With the vote split therefore not an accurate indication of the change in the MPC’s view on rates, markets were left to extract this signal from the meeting minutes and press conference. Here, the MPC appeared to retain a modest tightening bias in its collective judgement, with Governor Bailey quoted as saying that the discussion of interest rate cuts is “too early”. Furthermore, the Bank’s framing of how long rates will need to be kept restrictive has firmed somewhat too, shifting from “sufficiently long” to an “extended period”. Nevertheless, today’s communications are hardly indicative of policymakers looking to conduct further rate hikes, evidenced not only by the fact that the core of the Committee voted for a hold but also by the minutes highlighting brewing concerns that the Bank has overtightened.
As such, whilst we don’t rule out the idea that the BoE could deliver more tightening if inflation cools much more slowly than expected, in our view policymakers have set a high bar to restarting rate hikes once again.
On the flip side, we are a little more sceptical. Whilst the BoE implied rate cuts would likely not occur next year, weak growth and a cooling labour market suggest to us that rate cuts will likely be delivered starting in the second half of 2024. This view is shared by markets, where the first rate cut is priced for August, but seemingly runs contrary to the Bank’s forward guidance, which stressed that its constant rate forecasts aren’t too dissimilar from its market-implied forecasts. Although Governor Bailey was at pains to say that the Bank’s guidance was aimed at influencing the SONIA curve, that rings as quite hollow given the bulk of today’s communications seemed to be aimed at pushing back on expectations of rate cuts, even as the forecast adjustments tilted in favour of a loosening in the labour market and higher recession risks.
The Bank paints a bleak outlook for UK growth, both in the near and long-term
With the Bank of England’s policy decision largely meeting expectations, financial media coverage is likely to centre on the considerable downgrade to its economic growth projections. Despite being conditioned on a lower market implied path for Bank Rate, the BoE has revised down its overall growth path such that the UK economy is seen to be 1% below that projected in August at the end of its forecast horizon.
Now, the BoE expects marginal growth next year, 0.25% in 2025, and 0.75% in 2026. This is uninspiring in the context of inflation that isn’t expected to fall back to target until late-2025.
The flatter growth profile reflects weaker-than-anticipated activity data since August, which suggests a slight contraction in growth in Q3 in our view relative to the Bank’s current forecasts of no change and August’s projection of 0.4% QoQ expansion, alongside the removal of its subjective judgement that previously boosted expected demand – this was based on a number of factors but primarily related to strength in the labour market, which boosted real wage growth and lowered the level of precautionary savings. Now, the Bank expects the savings ratio to be broadly unchanged, owing to the higher profile for unemployment.
BoE’s growth forecasts are downgraded significantly across the entire forecast horizon
A tighter labour market is seen as underpinning the slow return of inflation to target
Despite a downgrade to the BoE’s growth forecasts, a lack of growth to the supply side of the economy meant that the associated fall in inflation projections was marginal. Indeed, it was notable that the MPC chose today to update their estimate for the neutral rate of unemployment to 4.5%, suggesting that conditions in the labour market are tighter than they previously thought. On this score, today’s messaging took special care to stress that moving forward the primary driver of inflation would increasingly come from services. Previously this had been linked strongly to progress on the ONS’s measure of private sector pay growth, though given concerns over the reliability of this data series, more emphasis is now being placed on a broader suite of labour market indicators.
This painted a more of a mixed picture of the UK economy than the ONS data, with some such as the REC report on jobs having suggested a cooling labour market for some time.
Even so, all measures remain significantly elevated, with this underpinning the BoE’s projection that inflation will take some time to return back to target, and even then only slowly. As such, Bank staff’s mean projection for CPI inflation is 2.2% at the two-year time horizon, and 1.9% at three years conditional on the market-implied path for Bank Rate.
Services inflation has begun to cool, but both elevated private sector pay growth and BoE forecasts suggests progress will be slow in returning back to 2%
Today’s BoE decision was not a game changer for sterling, although it did see Gilt yields drop alongside market expectations for Bank Rate, which briefly saw an August 2024 rate cut fully priced.
Whilst this has partially retracted following the end of Bailey’s press conference performance, traders are still not fully buying the BoE’s hawkish noises, with swap markets seeing 35bps of rate cuts by the end of Q3 next year. While lower Gilt yields have previously been associated with a weaker pound, given the rising recession risks in Europe and the drop in longer-dated Treasury yields, the move lower is now providing risk assets and thus sterling with a bit of a boost.
Authors:
Simon Harvey, Head of FX Analysis
Nick Rees, FX Market Analyst