The Bank of England is set to leave interest rates on hold on Thursday but the divergence between hawks and doves could become more pronounced as worries over inflation are reflected in another split vote and a jump in CPI the day before the decision.
Despite expected higher inflation numbers, which are due out Wednesday, increasingly I think the hawks are looking like they’re out an a limb; I expect markets to rightly reprice for the Bank not to hike this year.
I have consistently said the next move for the Bank is a cut – not something the gilt futures curve is currently priced for, albeit the 2yr gilt yield has declined about 40bps since the last BoE meeting. Markets now see just a 25% chance of a hike next month and are priced for just one 25bps increase this year, down from 3 hikes priced at the peak.
Still, the bias is towards tightening and I think this is misplaced.
CPI inflation for May is seen rising to at least 3.0% from the 2.8% recorded in April. But with the US-Iran peace deal looking positive for energy markets (ie lower prices), there will be no appetite among the majority of rate-setters to hike. Lower gas futures prices in particular indicate that CPI won’t breach the 4% level that is particularly sensitive for the BoE – last year it indicated that CPI north of 4% was when it became more entrenched. We are not at this level and I don’t think we will get there – this is not 2022.
Governor Andrew Bailey will lead a majority vote in favour of leaving rates on hold at 3.75%. In my view a majority within the nine-strong Monetary Policy Committee made it pretty clear at the last meeting that they were prepared to look through a temporary rise in inflation due to the spike in energy costs from the Iran war. This week’s peace deal and subsequent drop in crude oil prices would tend to suggest they were right to do so, though of course the data remains the key.
At least a couple of rate-setters, led by chief economist Huw Pill and external member Megan Greene, think the Bank should act proactively to contain second order inflation effects. The usually hawkish Catherine Mann may join them, but I think on balance given the peace deal she would prefer to wait until July before making a call. Repeat this is not 2022.
The meeting comes after the European Central Bank and Bank of Japan both hiked rates. Meanwhile bets are increasing for the Federal Reserve to hike this year. But I do not believe the UK is in the same position as peers and needs to avoid prematurely raising rates. That’s why I expect this week to be critical for FX markets and cable in particular as monetary policy divergences will start to be reflected in market pricing.
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