The Bank of England voted 6-3 in favour of raising rates by 25bps to 1.25%. The dissenters (Haskell, Mann, and Saunders) all voted to hike rates by 50bps, in order to mitigate against risks that wage growth, firms’ pricing decisions, and inflation expectations fuel persistence in above-target inflation.
While the increase in Bank Rate and vote split largely met market expectations, despite being a hawkish surprise relative to our view, the Bank continued to strike a more aggressive tone in their fight against inflation in the meeting minutes. Although the minutes acknowledged a slower growth backdrop than previously anticipated, they made repeated reference to the strong momentum in the UK labour market and the broadening of inflation pressures in the services sector. The prospect of self-sustaining momentum in domestically-generated inflation, despite the expectation that slack is set to open up in the economy in due course, forced the doves back in line in a similar fashion to how May’s CPI report forced the Fed into conducting a larger 75bp hike last night.
The MPC now remains committed to conducting policy in a data-dependent manner, opening up two-sided risks to the projected policy path going forward.
In the context of today’s more hawkish decision, however, the Bank’s reference to the “scale, pace and timing of any further increases” reflecting incoming data will be read through rose tinted glasses by economists pushing for continued tightening. In contrast, we would argue that the Bank’s core messaging hasn’t changed, despite increased concerns over services inflation. In the coming months, consumer demand conditions are only set to deteriorate under the cost-of-living pressures, while growth conditions generally are set to moderate as reopening factors fade and previous policy tightening filters through. This suggests that firms may struggle passing on increased costs to consumers, meaning the path for UK interest rates going forward isn’t as clear cut as markets and most sell-side economists predict. While we still expect the Bank to pause its hiking cycle after getting Bank Rate to 1.5% in August, we note that in light of today’s decision, the risks of a continuation in the hiking cycle to 2% by year-end have increased as the Bank prioritises tackling inflation over supporting the real economy.
The pound has whipsawed in response to today’s decision. After initially selling off as rates markets priced a more dovish policy path going forward—the prospect of 50bp hike in August was briefly priced out of overnight interest rate swaps—the retracement in money market pricing saw sterling traders buy the dip. The next 24 hours were set to be huge for the pound, with retail sales data for May scheduled to be released tomorrow morning shortly after the Bank said the consumer backdrop is holding up well under the pressure of inflation. Nevertheless, the data release has been moved to next Friday instead, meaning another session of increased GBP volatility is going to have to wait until next week, when the data calendar also includes May’s CPI report.
Sterling whipsaws as money markets adjust to the Bank of England’s new messaging
Simon Harvey, Head of FX Analysis