Economic uncertainty begets policy uncertainty

With an unusually wide vote split, the Bank of England (BoE) today lifted its bank rate by 50bp to 3.5%. The move was in line with our and the market’s expectations. The slower pace of tightening versus November, when policymakers hiked by 75bp, signals that a majority on the committee are growing confident that monetary policy is close to turning sufficiently tight to return inflation to the 2% target. However, the vote split also highlights a high degree of uncertainty about what the BoE will do at upcoming meetings. Whereas six of the Monetary Policy Committee’s (MPC) nine members backed the 50bp move, two members preferred to keep rates on hold and one preferred to hike by a higher 75bp.

According to the November minutes, the UK economy will be ‘in recession for a prolonged period and CPI inflation was expected to remain very high in the near term. Inflation was expected to fall sharply from mid-2023, to some way below the 2% target in years two and three of the projection’. Even though policymakers expect inflation to fall below target within a policy relevant horizon of two years, ‘the risks around that declining path for inflation were judged to be to the upside.’ Policymakers remain most concerned about elevated wage pressures. Given the outlook for falling inflation, the decision to hike again at the November meeting appears to be on risk management grounds. Future such moves may be harder to justify as inflation falls further and the UK recession deepens.

Data dependant? Sort of

In its updated forward guidance, the BoE notes that ‘should the economy evolve broadly in line with the November Monetary Policy Report projections, further increases in Bank Rate might be required for a sustainable return of inflation to target.’ This statement is ambiguous to say the least and opens the door for policymakers to hold rates at the next meeting in February, even if the economy evolves in line with expectations. The minutes also note that ‘the Committee would, as always, consider and decide the appropriate level of Bank Rate at each meeting’.

We take these statements as de facto meaning that the BoE is close to peak rates – and may be there already – but will decide on any further hikes based on how the economy and inflation expectations evolve. Leaning back, even though one policymaker wanted to hike the bank rate by 75bp in this meeting, the shift in the voting pattern is decidedly dovish. In November seven members voted for a 75bp hike, one voted for a 50bp hike and one voted for a 25bp hike. Judging by this trend, the outlook for February looks likely to be a close call between no further hikes and a final 25bp hike.

Policy outlook

In our view, it makes sense for policymakers to hold off on any further rate hikes until it becomes clear whether there remains any serious underlying inflation problem in the UK, once the base effects of high energy prices wash out and the disinflationary forces of recession and tighter financial conditions have fully impacted price pressures. This will become more obvious in coming months. However, given the still-cautious tone over inflation risks, markets should be prepared for a further 25bp hike at the February meeting.

Additional positive inflation surprises in coming months – in the UK and abroad – would weaken the case for a further hike, however. Further out, we expect the BoE to partly unwind some of the rate cuts once inflation falls to target. However, amid fears that inflation could take off again during the next economic upswing, this is likely to be in the region of 50bp in cuts during H2 2023 rather than aggressive cuts towards zero as we had become accustomed to in the decade after the financial crisis.

Kallum Pickering
Senior Economist, Director

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