General view of the Royal Exchange, the Bank of England and the City of London on an overcast day.
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LONDON — The Bank of England’s monetary policy committee will meet on Thursday to decide whether to pull the trigger on interest rate hikes.
Policymakers have hinted a hike is imminent, but the nine-member MPC will have to consider whether to tighten policy this week or wait for its mid-December meeting, in light of persistent above-trend inflation and moderate growth.
Markets are uncertain about the timing, with analysts suggesting the vote will likely be split. Some BOE policymakers, such as Governor Andrew Bailey and famed hawk Michael Saunders, hinted they might support an immediate hike, while others seemed more reluctant.
Silvana Tenreyro recently reported that she need to see other labor market data following the end of the UK’s furlough scheme on September 30 before voting to begin the path to policy normalization.
As of Monday’s close, market data showed derivatives traders were pricing in a 64% chance of a 15 basis point rate hike this week, Berenberg pointed out in a note Tuesday. Senior Economist Kallum Pickering said while his team considers a first hike in December “slightly more likely”, a move this week would not come as a surprise.
Pickering noted that an increase in the base rate of 15 basis points from its current all-time low of 0.1% would keep monetary policy ultra loose, but could have a significant impact on rate expectations, which have changed dramatically over the past month.
“After advancing the first hike from March 2022 to November 2021 since early October, the market now expects the Bank Rate to rise to 1.25% by the end of 2022, followed by 40 basis points of decline from mid-2023 to late 2025,” he said.
“Essentially, the market appears to be expecting a policy error from the BoE in the coming years in the form of excessive tightening in 2022 to be corrected by modest rate cuts thereafter.”
As such, Berenberg thinks of a first move on December 16 and a rise to 0.75% by the end of 2022, with further hikes in 2023 taking the Bank Rate to 1.25% around a year. year later than current market expectations.
Whether or not the Bank raises rates on Thursday, Berenberg expects the MPC to send a clear signal in its forecast.
The path to tightening is complex
At the heart of the MPC’s headaches is the unique nature of the pandemic recovery, in that policy positions can change as incoming data changes, particularly with respect to growth and inflation.
UK inflation unexpectedly slowed in September, rising by 3.1% in annual terms, but analysts expect this to be a brief respite for consumers. The 3.2% annual rise in August was the largest increase since records began in 1997 and well exceeded the Bank’s 2% target.
GDP rose 0.4% in August after an unexpected contraction of 0.1% in July, as staff absences linked to the Covid-19 Delta variant jumped.
“Like other major economies, the UK is experiencing significant supply bottlenecks and a highly uncertain inflation outlook due to conflicting signals between indicators,” said Gurpreet Gill, macro strategist for Global Fixed Income at Goldman Sachs Asset Management.
High vacancies indicate a tight labor market that supports higher wage growth, Gill pointed out, while hours worked and labor force participation rates suggest significant spare capacity. UK job vacancies hit a record 1.1 million in the three months to August, while the average unemployment rate fell.
Additionally, a drop in immigration following Brexit and the pandemic could ease longer-term pressures on labor supply in the UK relative to other major economies.
“As the next MPC meeting approaches, all eyes will be on incoming data, including inflation expectations and business sentiment,” Gill said.
“The path to monetary normalization is unlikely to be smooth, when the data on which the MPC makes decisions is highly variable.”
Whether the first monetary policy tightening comes on Thursday or in December, analysts generally agree that market expectations mean the Bank should continue to rise this year.
Michel Vernier, head of fixed income strategy at Barclays Private Bank, said the BOE’s expectations of inflation rising to 4% may need to be revised upwards as supply chain hurdles appear stiffer. and energy prices exerting continued upward pressure.
However, Vernier said inflation is still “very likely” to moderate quickly, once the pandemic-induced output gap is closed.
“Inflation would now also be capped by early hikes, which could even leave room for the BoE to reverse its decisions at a later stage if persistent excessive inflation does not materialize,” he said.
“Recent comments from the BoE on the urgency to act indicate that there appears to be a stronger focus on protecting consumers from higher inflation (GFK consumer sentiment has recently consolidated, rates higher mortgages could put additional pressure).”
However, Barclays Private Bank is also betting on a rise in December, with a further 50 basis point hike by mid-2022 now a “strong possibility”.