Central banks remain in the spotlight again today thanks to the BoE’s policy decision, which is out at 12:00 London time (8:00AM ET). Markets are fully pricing in the BOE's first post-pandemic rate hike of 15bps, taking the Bank Rate up to 0.25%, as well as end their current QE program.
Similarly to the US, this comes amidst inflation readings that have persistently surprised to the upside over recent months, with CPI at +3.1% in September, and economists expect the BoE’s forecasts being upgraded to show peak CPI nearer to 5%, remaining above target for nearly all of next year, which is broadly in line with recent comments from Chief Economist Pill in a recent FT interview.
As Bloomberg's Dan Hanson writes in his BOE preview, there’s a fierce debate raging on the Monetary Policy Committee about whether to raise interest rates Thursday. Financial markets think it’s a done deal, thanks to a series of hawkish interventions by Governor Andrew Bailey. "We’re less sure. Our baseline is the MPC holds, teeing up a hike for December, assuming the end of the furlough scheme doesn’t knock the labor market off course."
Hanson's team breaks with consensus and expects policy makers to vote 5-4 in favor of keeping rates on hold at 0.1%. He also thinks Deputy Governor Dave Ramsden and Michael Saunders will support ending the current QE program early. The remainder of the committee is likely to vote in favor of maintaining the asset purchase target at 895 billion pounds.
Deputy Governor Ben Broadbent is seen as the key voter in the rates decision and assume he will want to see the post-furlough labor market data before voting to lift rates. That information will be available ahead of the December meeting.
There’s another reason to hold off. Delaying the hike would allow the MPC to deliver a cleaner message about the aggressive tightening cycle being priced in by markets.
We expect the committee to share our view that the economic fundamentals haven’t improved sufficiently to justify current pricing. Markets now see rates rising by more than 100 bps by the end of 2022 -- in August, the committee thought just 50bps of tightening over three years was enough to bring inflation back to the central bank’s 2% target.
Whether rates go up or not, the MPC is likely to send that signal using its forecasts, which are conditioned on the markets implied path of rates. Inflation will probably be seen settling below target in the medium term. Our scenario model SHOK illustrates that the balance of fiscal and monetary news since August will push down on medium-term inflation, all else being equal.
For many on the MPC, there’s a big perceived danger of losing credibility if tightening begins too late. So if enough members of the committee see the risks to the labor market as low and are sufficiently relaxed about market pricing for next year, the MPC will defy Hanson's expectations and deliver a 15bps hike, taking the policy rate to 0.25% from 0.1%.
It’s a tight call that has divided opinion among economists.