Bank of England silent ahead of rate hikes
The Bank of England’s had a strained relationship with investors over the past few months. GBP has struggled for meaningful direction against volatile forecasts for the global economy and some messy guidance from the Bank of England hasn’t helped.
First came the November misunderstanding over rate hikes that didn’t materialise (despite comments from Governor Bailey & Economist Pill that the market interpreted as hawkish).
After this fallout, the omicron variant added an extra layer of uncertainty for the December meeting. Two weeks beforehand Catherine Mann said it was premature to talk about interest rate rises.
Then she voted for a 15bps hike… The Bank of England’s reputation as the ‘“unreliable boyfriend” was secured. Mann was back in the headlines as recently as January 21st, saying:
“Monetary policy should now temper expectations for wage and price increases in 2022 to avoid them from being ingrained in business and consumer decision-making.”
Reading between the lines, the Bank of England ARE worried about inflation, and tightening seems to be the path now. The main questions:
- How much?
- How fast?
- And what will it all mean for the pound?
Let’s break that down.
Rate hikes: what does the market expect?
Using MPC SONIA futures as a proxy for interest rate expectations gives an idea of how the market views things:
Markets expect the base rate to be at 0.76% by June & above 1% by the September meeting. Goldman Sachs argue that it could be sooner:
“We now expect the BOE to hike in back-to-back meetings through May, in order to demonstrate to markets and businesses that the MPC is serious about the inflation target, and will act to ensure the U.K. does not face the risk of a wage-price spiral,”
That would equate to three 25bps hikes over the next three meetings, bringing the rate to 1% sooner than consensus.
2022 Bank of England meeting dates:
UBS expects a slightly slower pace of 25bps hikes in February, May & August.
- With inflation and growth likely to slow at the time of the August meeting following a Q2 bounce, they suggest that the Monetary Policy Committee will prefer to avoid raising rates much above 1% and defer the discussion on an active balance sheet unwind.
Goldman Sachs agree on the active part of the balance sheet unwind: “We expect the BOE to announce a fixed and gradual schedule of asset sales to begin in the summer, after hitting the stated 1% threshold in May,” “While highly uncertain, we are expecting asset sales of around 20 billion pounds per quarter.”
How to unwind the balance sheet…
Analysts are referencing the Bank of England’s August monetary policy report and saying that the Bank of England’s threshold for a soft (passive) Quantitative Tightening has been met. This is the section in question (with some added emphasis):
The MPC’s current approach to the sequencing of monetary policy tools:
Taking the above factors together, the MPC intends to begin to reduce the stock of purchased assets when the Bank Rate has reached 0.5%, if appropriate given the economic circumstances.
The MPC judges that the reduction in the stock of purchased assets should initially occur through ceasing the reinvestment of maturing assets, to allow the reduction to occur at a gradual and predictable pace.
This was the ‘current’ approach back in August last year. For context, the same report also said that “the Committee’s central expectation is that current elevated global and domestic cost pressures will prove transitory ”.
It’s fair to question if this policy will still be considered appropriate by the MPC. Those statements were made months ago when central banks believed inflation would fade and they’d have the luxury of gradually tightening policy back to neutral.
That simply isn’t the case now. Inflation keeps beating expectations and labour shortages have stoked fears of the dreaded wage-price spiral.
So it’s worth noting another section of the August MPC report:
“The Committee’s preference is to use Bank Rate as its active instrument in most circumstances. The MPC has greater certainty around how changes in Bank Rate affect the economy compared with its other policy tools. Changes in Bank Rate can also be operationally easier and quicker to implement.”
If the Bank of England have decided to hike aggressively (Godldman’s scenario), it would be no surprise to see them remove the balance sheet from the equation, preferring instead to focus on the primary tool (rate hikes), and return to the subject of balance sheet management in the summer.
Far easier and clearer to communicate.
What does this mean for GBP?
With the Federal Reserve & Bank of England at the head of the hike queue, let’s contrast GBP with EUR, and the ECB stance that no hikes will be necessary in 2022. Money markets are challenging that perspective and pricing 25bps of hikes by December 2022.
The EURGBP chart remains in a solid downtrend, although the euro bounced slightly to start the week.
The pair still sits just above the ‘make or break’ key support zone at 0.82760 and these monetary policy differences could drive the next impulse move. There’s another side to consider too.
What if the ECB is right?
While other central banks are hawking it up, the ECB has stuck to Plan Transitory. Could the market get ahead of itself in hawkish pricing and find that EUR is undervalued on a relative basis?
A couple of key factors influencing the BOE are starting to moderate.
According to the latest Citi/YouGov survey "[longer term inflation] expectations remain anchored overall."
Inflation expectations are still too high at 3.8% but they haven’t increased either…
And a monthly Lloyds survey suggests that the proportion of businesses expecting to raise pay by 2% fell to a five-month low of 41% from 48% in December.
- Hiring intentions were slightly less positive this month and seem to have moderated recently, although the percentage of firms that expect to expand their workforce in the coming year is still relatively high. Pay pressures appeared to have eased back this month.
Limited pay hikes (and way below the rate of 5.4% inflation rate) drastically reduces the chances of a wage-price spiral.
All of which leaves things very open beyond the February meeting. A hike seems nailed on, but investors may find it’s a little premature for certainty about the path beyond that.
Not investment advice. Past performance does not guarantee or predict future performance.
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