News & analysis

The Bank of England held rates at their first policy meeting of the year, a move widely expected by markets and in line with our pre-announcement call. Despite the lack of action, today’s communications offer some interesting hints on the likely path for Bank Rate in the coming months.

Most significantly, though also widely anticipated, the Bank dropped its hiking bias, turning more neutral in its forward looking guidance. It similarly downgraded its short run inflation forecasts in light of better-than-expected data and made note of weaker than projected growth at the end of 2023. Despite this, it is notable that the Bank continues to highlight uncertainty around inflation returning sustainably to target, with wages and services price growth remaining a concern. As we have previously noted, April’s rise in the National Living Wage would likely be the major concern for policymakers in the near term, a point seemingly confirmed by the attention it received in this latest Monetary Policy Report.

Therefore, whilst we continue to think that inflation will slow sharply in coming months, that the full impact of this National Living Wage rise will not be apparent until after the June meeting, we continue to expect the Bank to stand pat until the second half of 2023 before delivering rate cuts. However, given the BoE’s emphasis on qualitative data, there is a risk that if wage effects aren’t seen transmitting through to higher output prices in the Q2 Agents survey, the BoE lowers rates at June’s meeting.

Nevertheless, the general tone of today’s communication suggests that cuts to Bank Rate are unlikely to be forthcoming soon. This was reflected in the MPC vote split, with two members voting for a further hike (Haskel and Mann) and one member for a cut in rates (Dhingra). Indeed, we think this latest set of communications offers little meaningful change from the BoE, despite the removal of the phrase that “Further tightening in monetary policy would be required if there were evidence of more persistent inflationary pressures.”, which in isolation could have been seen as dovish. But as pointed out by Governor Bailey in his press conference, this just moves the key question to how long should rates stay at their current position for, in effect restating the Bank’s prior high for longer/table mountain guidance. This more conservative message was shared in the Bank’s view that inflation would only temporarily fall to 2%, as opposed to below 2% as most sell-side analysts predicted, in the second quarter before rising again in the second half of the year, and a reference that financial conditions have loosened since the December meeting, with Deputy Governor Broadbent noting that 2-year real rates have fallen significantly in recent weeks.

In driving home their more cautious outlook on the policy path, the Bank of England stressed concerns about inflation persistence, to which wages and services inflation were key.

To this point, there was little change in the Bank’s assessment that wage growth, whilst falling, will be sticky at an elevated rate for some time. This in turn sees services inflation only slowly return to target in Bank staff forecasts, with strong wage growth set to fuel inflationary persistence. In our view, however, the Bank continues to overestimate both the stickiness of wages and the passthrough to inflation going forwards. Notably, private sector regular pay has softened more than headline figures have indicated recently, seen by the drop of the single month figure which has now fallen to 6%. Most significantly though, on a three month average annualised basis, wage growth has dropped below 2%, a level that would see inflation fall below target if sustained over time.

Wages have slowed sharply over recent releases, with further cooling in the first half of 2024 set to prompt BoE easing from August

Indeed, even if wage growth did pick up from these low levels in coming months, this should now be less of a concern. As highlighted in the MPR, demand and supply were broadly balanced in 2023 Q4, with a margin of excess supply expected to emerge in 2024. This should see the ability of firms to pass on rising costs reduce, a dynamic already hinted at in January’s flash PMI report. Even so, we think the Banks focus on the upside risks posed by wages means that they will need to see the impact of April’s rise in the NLW before a majority of the MPC feels comfortable cutting rates. On this point, today’s MPR dropped what we think is a significant hint that the MPC would not be satisfied seeing the first-round impact of the wage rise, but are instead concerned with potential second round effects.

With these only set to be visible in official data following the June meeting, we think the BoE has now confirmed our call that the NLW rise will keep them on hold until August. But with little pushback by BoE speakers on a conditioning path that foresees rapid rate cuts later this year, we suspect the BoE is keeping an open door to deliver four rate cuts from this point, in line with our base case.

 

 

Authors:
Simon Harvey, Head of FX Analysis
Nick Rees, FX Market Analyst

 

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