Pound Slides After BOE Holds Rates: Warns Q4 Economy "Slightly Softer", Sees "Gradual And Limited" Rate Hikes

As previewed moments ago, the BOE decision was rather unexciting, and after its November rate hike - the first in a decade - which many speculated could be a "one and done", the Bank of England unanimously kept rates unchanged at 0.50% as expected. The lack of dissenters meant this was the first time the nine policy makers have been in agreement since February. The committee also left the BOE's QE unchanged.

Here are the highlights from the press release, which suggested that 4Q economic indicators were softer than expected and that inflation "may be close to its peak", and concluding that "any future increases in Bank Rate are expected to be at a gradual pace and to a limited extent."

  • The recent news in the macroeconomic data has been mixed and relatively limited. Domestically, some activity indicators suggest GDP growth in Q4 might be slightly softer than in Q3.
  • Although it is too early to arrive at a comprehensive view of the effect of November’s rise in Bank Rate on the economy, the impact on interest rates faced by households and firms has been consistent with previous experience.
  • CPI inflation was 3.1% in November. It remains the case that inflation has been pushed above the target by the boost to import prices that resulted from the past depreciation of sterling. The MPC judges that inflation is likely to be close to its peak, and will decline towards the 2% target in the medium term.
  • The steady erosion of slack over the past year or so has reduced the degree to which it is appropriate for the MPC to accommodate an extended period of inflation above the target. Consequently, at its previous meeting, the MPC judged it appropriate to tighten modestly the stance of monetary policy in order to return inflation sustainably to the target
  • Any future increases in Bank Rate are expected to be at a gradual pace and to a limited extent.

So while the BOE's Monetary Policy Committee reiterated that “further modest increases” in the key rate would probably be needed over the next few years if the economy performed as expected, it did not provide additional detail on the timing, and said "any future increases in Bank Rate are expected to be at a gradual pace and to a limited extent." Meanwhile, markets aren’t pricing in another increase until late 2018, and some observers say the bank may not move at all next year, if ever.

The BOE's latest analysis also cited two "significant events' in the past month, both of which could be positive for the economy. It said Chancellor Philip Hammond's Budget in November would lift both economic growth and inflation in the coming years and noted the progress in the U.K.'s withdrawal negotiations with the European Union. On Brexit, which remains the “main challenge” for monetary policy, the BOE said the latest developments reduce the chance of a disorderly exit. They are also “likely to support household and corporate confidence,” it said.

Hinting that the recent surge in inflation is finally peaking, and sending a modestly dovish message, the BOE said that "it remains the case that inflation has been pushed above the target by the boost to import prices that resulted from the past depreciation of sterling" and judged that "inflation is likely to be close to its peak, and will decline towards the 2% target in the medium term." 

As reported on Tuesday, Mark Carney will be writing an open letter to the Chancellor of the Exchequer, accounting for the overshoot relative to the target and explaining the MPC’s policy strategy to return inflation sustainably to the target.  This letter will be published alongside the minutes of the February 2018 MPC meeting and the accompanying Inflation Report.

And while the bank sees a gradual pickup in domestic inflationary pressure, maintaining its view from November, when it lifted interest rates from a record-low 0.25 percent, for now inflation remains far above the central bank’s 2 percent target, boosted by the pound’s weakness following Britain’s 2016 vote to leave the EU.

As Bloomberg notes, while price growth is forecast to ease next year, the bank is concerned about a buildup of unwelcome domestic inflation pressures due to persistently sluggish productivity growth and a Brexit-related loss of labor supply. That analysis played a large part in driving November’s rate hike. Since then, policy makers have presented a fairly united front in public, with few signs of overt dissension from the view that two more increases may be needed in the next three years to meet the inflation target. The BOE also noted that recent indicators of economic growth this quarter have been “softer than expected.” It repeated its line that any rate increases will be limited and gradual.

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It appears that market expected more hawkishness from the BOE - which failed to release any hawkish hints - and as a result, the pound erased gains, sliding 30 pips to trade little changed, down to 1.3425 after rising as high as 1.3466 before the announcement. As Bloomberg notes, some analysts were positioned for a slightly hawkish rhetoric given signs of progress in the Brexit talks in recent weeks.

That said, money- markets are pricing the next rate increase in November 2018.