BoE hikes 50bp, but uncertainty clouds future tightening path

BoE hikes 50bp, but uncertainty clouds future tightening path

The vote split indicates that the MPC committee was almost fully aligned this time with 8-1 MPC members that voted for a 50bp rate increase. This quasi-unanimity among MPC members reflects rising inflation concerns but most importantly the urge to well-anchor inflation expectations around the 2% neutral level. During the press conference, BoE Governor Bailey highlighted the exceptional high uncertainty surrounding the BoE’s forecasts and as such, the BoE will follow the ECB and the Fed's path of setting policy ‘’meeting-by-meeting’’. Bailey stated that the BoE has moved from a system of ‘’predictive forward guidance to a framework that is not predictive’’.  Therefore, ‘all options are on the table’ for future meetings.

The BoE's Monetary Policy Report was published today, with updated forecasts. The August report offers a much darker economic outlook for the UK compared to the previous report published in May. Inflation is now expected to peak at 13.3% in 2022Q4 and remain elevated for longer than anticipated, with inflation at 9.5% (vs 5.9% prev) in 2023Q3. These inflation pressures continue to be mainly driven by the energy crisis caused by the Russian invasion of Ukraine, with wholesale gas prices almost doubled due to Russia’s restrictions on gas supplies since May’s report. However, the BoE now also projects a bigger undershoot of its 2% inflation target three years out, with inflation expected to fall to 0.8% in 2025Q3 compared to 1.3% in May’s report for the 2025Q2 inflation figure. Meanwhile, the MPC is now projecting a recession in 2022Q4, which will continue until the end of 2023, marking a huge downgrade relative to its May forecast. GDP growth is projected to slow sharply at -2.1% YoY (vs -0.8% prev) and 0% (vs 0.4%) in 2023Q3 and 2024Q3, respectively. While unemployment is projected to rise to 5.5% in 2024 (vs 4.8% prev) and 6.3% in 2025 third quarter. It is important to note here that the BoE's projections are based on market expectations for Bank Rate, and as such suggest market expectations continue to be too aggressive given the large undershoot in inflation projected later on the horizon.

Might the BoE need to start cutting rates at some point?

The updated projections and the ambiguous guidance on rates triggered strong reactions in financial markets with the 2s10s inverting for the first time since 2019, which signals that markets are pricing in a recession. Market expectations are now front-loading interest rate hikes and expect Bank Rate to peak earlier and at a higher level of around 2.9% by February 2023 compared to 2.7% a few days ago. Following today's updated guidance and projections, we stick to our current forecast and expect the Bank rate to peak at 2.5% end of the year, which remains below market expectations. In the near term, we expect the BoE to continue its monetary tightening and expect a 25bp rate hike in the next meeting, but see upside risks for another 50bp rate hike in September given hawkish concerns over domestic inflationary pressures, particularly wage growth. However, we think that by later this year, the economy should have sufficiently weakened to drive a rise in unemployment and a cooling in wage growth. Combined with a deeper expected fall in inflation in 2024-25, this could raise the prospect of the MPC reversing course and cutting rates to support growth, perhaps in H2 2023. Indeed, the MPC’s projections from today’s report point to a significant rise in unemployment and an undershoot of the 2% inflation target in the medium term.