Over ten years since the last rate hike by the Bank of England in July 2007 (when incidentally, cable was trading above $2.00), and following years of market expectations of an imminent rate hike that failed to materialize...
.... moments ago the BOE - which had telegraphed the move extensively in recent months despite some dovish misgivings - finally pulled the trigger, and raised rates by 25bps to 0.5% in order to curb the effect of high inflation brought about by the post-Brexit plunge in the pound, squeezing local households and pressuring the UK economy. However, while cable initially spiked higher on the news, it subsequently slumped on the news that the vote was not a unanimous 9-0 decision as some had expected, as would telegraph a normal rate hike cycle, and instead had a decidedly dovish tilt with a far more contested 7-2 vote, with Cunliffe and Ramsden dissenting based on insufficient evidence that domestic costs, particularly wage growth, would pick up in line with central projections.
Here is the BOE assessment:
The Bank of England’s Monetary Policy Committee (MPC) sets monetary policy to meet the 2% inflation target, and in a way that helps to sustain growth and employment. At its meeting ending on 1 November 2017, the MPC voted by a majority of 7-2 to increase Bank Rate by 0.25 percentage points, to 0.5%. The Committee voted unanimously to maintain the stock of sterling non-financial investment-grade corporate bond purchases, financed by the issuance of central bank reserves, at £10 billion. The Committee also voted unanimously to maintain the stock of UK government bond purchases, financed by the issuance of central bank reserves, at £435 billion.
Some other key BOE considerations:
- Growth: GDP grows modestly over the next few years at a pace just above its reduced rate of potential. Business investment is being affected by uncertainties around Brexit, but it continues to grow at a moderate pace, supported by strong global demand, high rates of profitability, the low cost of capital and limited spare capacity.
- Consumption: Consumption growth remains sluggish in the near term before rising, in line with household incomes
- Trade: Net trade is bolstered by the strong global expansion and the past depreciation of sterling.
- Inflation: After CPI rose to 3.0% in September, the MPC still expects inflation to peak above 3.0% in October, as the past depreciation of sterling and recent increases in energy prices continue to pass through to consumer prices. Expects domestic inflationary pressures to gradually pick up as spare capacity is absorbed and wage growth recovers.
- Wages: The central projection was that whole-economy total pay growth was expected to rise from a little over 2% to 3% in a year's time, levelling out at around 3.25% in the medium term.
- Brexit: Uncertainties are weighing on domestic activity, which has slowed even as global growth has risen significantly. Brexit-related constraints on investment and labour supply appear to be reinforcing the marked slowdown that has been increasingly evident in recent years in the rate at which the economy can grow without generating inflationary pressures.
- Slack: slack has reduced the degree to which it is appropriate for the MPC to accommodate an extended period of inflation above the target
There remain considerable risks to the outlook, which include the response of households, businesses and financial markets to developments related to the process of EU withdrawal. The MPC will respond to developments as they occur insofar as they affect the behaviour of households and businesses, and the outlook for inflation. The Committee will monitor closely the incoming evidence on these and other developments, including the impact of today’s increase in Bank Rate, and stands ready to respond to changes in the economic outlook as they unfold to ensure a sustainable return of inflation to the 2% target.
While the 7-2 vote split was clearly less hawkish than an ideal scenario would suggest, what has spooked traders are the following parts from the statement that appear especially dovish:
- In the MPC’s central forecast, conditioned on the gently rising path of Bank Rate implied by current market yields, GDP grows modestly over the next few years at a pace just above its reduced rate of potential.
- In line with the framework set out at the time of the referendum, the MPC now judges it appropriate to tighten modestly the stance of monetary policy in order to return inflation sustainably to the target.
- Monetary policy continues to provide significant support to jobs and activity in the current exceptional circumstances. All members agree that any future increases in Bank Rate would be expected to be at a gradual pace and to a limited extent.
In immediate reaction, as shown in the chart above, GBP/USD dropped as much as 1.1% to 1.3098 low as the 7-2 vote risks that Carney adopts a dovish approach at his press conference, as policy makers saw considerable risks stemming from Brexit. According to Bloomberg, bids at 1.3150-60 filled, with option related protection above 1.3100. One-week risk reversals at 31bps in favor of GBP puts, remain in sideways trading since mid-October.
So is this the start of a more traditional hiking cycle or just a one-off correction from last year's rate cut? According to the BOE, "all members agree that any future increases in Bank Rate would be expected to be at a gradual pace and to a limited extent." Incidentally, this is what the market expected just prior to the announcement.
Incidentally, the chart above may be right as BOE policy makers omitted language from previous statements saying that more hikes could be needed than the markets expect. That implies that officials are comfortable with pricing for two more quarter-point increases, roughly one by late next year and another in 2020.
Here is Bloomberg's take:
That’s a very prudent pace of rate hikes, the one the Bank of England is penciling in. And yet, despite the warning about the "considerable risks" coming from Brexit, it is still a path of tightening ahead. The dropped wording that interest rates may need to rise more than markets expect has markets recalibrating, with bond yields falling and pushing back expectations for a follow-up. It’s not a big reset, though, with a second quarter-point move now fully priced in for September 2018 (compared with August before the decision). That’s what the market expects
And with the overhang of more imminent rate hikes gone, Gilt yields have also tumbled.