Thursday’s MPC decision will be the least clear cut in years, with UK data uncertainty and global conditions providing compelling arguments for both an “insurance” rate cut and for no change.
Hard UK macro data such as retail sales and GDP have made it clear that the economy had a dismal fourth quarter, in large part due to political uncertainty from the general election and the risk of a no-deal Brexit.
In response to the run of poor data and shaky global conditions, several MPC members have made arguments for a pre-emptive rate cut over the past few weeks, most notably Michael Saunders and Gertjan Vlieghe.
As last week’s “Week Ahead” noted, markets duly began to price in a rate cut from the Bank of England, with GBP trading to lows for the year around the 14th of Jan.
Chart: OIS-Implied Probability of a rate cut shows this week’s MPC is a coin toss.
Since then, several data points have presented a serious challenge to the argument that easing is necessary now…
- The Q4 slowdown was likely triggered by extreme political uncertainty due to no-deal Brexit risk prior to the mid-October withdrawal agreement deal, and the general election in December. Now that these uncertainties have reduced substantially, the outlook for Q1 has improved.
- Early Q1 survey data released this week supports this idea: the flash Markit HIS purchasing managers’ indices for January showed the fastest increase in new work since 2018.
- The composite PMI, which is designed to be a good proxy for overall GDP growth, rose from 49.3 to 52.4, the fifth largest monthly jump in the history of the survey. This is consistent with a quarterly growth rate of 0.2%.
The MPC must balance the significant slowdown in growth seen in Q4 against the probable recovery that currently appears to be happening. Recent official communication outlines the way that this decision is likely to be approached.
The minutes from December’s meeting, when rates were kept unchanged, made it clear that January survey data would be relevant to near term policy making. Special emphasis was made on the Bank’s Agency network and Decision Maker Panel.
The minutes included a warning that policy would need to be eased if “global growth failed to stabilise or if Brexit uncertainties remained entrenched”. Looking at January’s PMIs and the signing of the US-China phase one trade deal, both of these factors have improved, not worsened.
November’s Monetary Policy Report projected a solid growth pickup in the second half of 2020, suggesting that Q4’s slowdown would be far less important for the MPC than the outlook for future growth.
On this basis, we believe the MPC will keep rates on hold this week, although this is the most finely balanced decision in years. Based off the improvement in business sentiment seen since the general election, sustained tightness in the labour market, and an easing in global concerns, the conditions set out by the November minutes for avoiding a rate cut appear to have been met.
Although it is not our base case expectation, a rate cut remains entirely possible, should Saunder’s arguments about risk based considerations take hold.
If the MPC does choose to follow Saunders’ reasoning in cutting rates due “risk management considerations”, it would be in line with a global trend of central banks increasingly emphasizing the asymmetry of risks facing policy makers in current conditions.
Chart 2: GBPUSD trading history
Given the 50-50 pricing in fixed income markets, GBP is likely to move significantly in response to the MPC decision on Thursday.
Put simply, with rates close to the zero lower bound, and upside inflation risk nowhere to be seen, there is a strong case for policymakers to err on the dovish side, to avoid the serious risk of being stuck in a zero rate vortex of the sort that has engulfed the ECB and BOJ.
Thursday’s vote will shed significant light on how popular this argument is among the MPC, regardless of the decision itself.
Author: Ranko Berich, Head of Market Analysis at Monex Canada.