13 December 2021
We have tempered our expectations for Bank of England interest rate hikes in the past few weeks, and now see it as unlikely that we’ll get the first pandemic era UK rate increase at this week’s MPC meeting.The November BoE meeting was a significant disappointment for markets. Going into the meeting, we expected the vote on rates to be a close one, with a handful of dissenters supporting an immediate hike. In the end, however, the vote was split 7-2, with only members Saunders and Ramsden seeing the need for a deviation from the status quo. Even governor Andrew Bailey, who had seemingly teed-up a hike in his October communications, unexpectedly sided with the doves. Since the November meeting, UK inflation has continued to exceed expectations. The headline measure of consumer price growth jumped to 4.2% in November (Figure 1), more than double the Bank of England’s 2% target and its highest level in almost a decade. Energy prices are rising particularly sharply, although we note that core inflation has also spiked, increasing to 3.4% last month - its highest level since April 2011. Deputy governor Broadbent said in early-December that UK inflation may now ‘comfortably exceed 5%’ by April 2022, partly a consequence of the country’s tight labour market. Figure 1: UK Inflation Rate (2011 - 2021)Source: Refinitiv Datastream Date: ##While the increase in domestic prices has undoubtedly strengthened the case for a faster removal of the BoE’s accommodative monetary policy settings, the detection of the highly mutated strain of COVID-19, omicron, provides a reason for caution. Not a great deal of specifics are yet known about the virulence of the new variant, although it does appear to be spreading at a rather rapid rate in much of the country and, according to experts, may become the dominant strain by the end of the year. In response, we have seen a tightening in restrictions across the UK. In England, mask wearing and covid passes have been reintroduced for a number of settings, while the government has again urged the nation to work from home if possible. The economic impact of said restrictions is likely to be minimal and we don’t necessarily expect additional measures to be announced just yet, particularly given the variant so far seems to largely be resulting in only very mild symptoms. The disruption to economic normality does, however, provide the MPC with a reason to be cautious and wait for additional news on the strain before committing to tighter policy. The latest monthly GDP report suggests that momentum may already be slowing, with the UK economy expanding by only 0.1% in October (Figure 2). Figure 2: UK Monthly GDP Growth Rate (2011 - 2021)
How will the MPC vote on interest rates?
Communications from MPC members have been dovish in the past few weeks, and it appears very unlikely that a majority of the nine will view immediate action as warranted. Catherine Mann warned that omicron could damage consumer confidence, saying that it was too soon to even talk about the timing of a rate hike. Ben Broadbent appeared undecided during his comments last week, while even notorious hawk, Michael Saunders, said he wanted more information on omicron before deciding on how to vote this month. Unlike in November, we think that a vote in favour of no change in rates would not necessarily trigger an immediate sell-off in the pound, given that expectations for a move are considerably lower this time around. Following the omicron news, markets have dialled back expectations for a December hike and are now pricing in less than a 50% chance of a 15 basis point move, having fully priced one in before the November meeting. We expect the vote to remain split 7-2, although the risk for sterling is that the vote is a unanimous one, with either or both of Saunders and Ramsden siding with the doves. In our view, this would undoubtedly weigh on the pound on Thursday afternoon. A closer 6-3 or 5-4 vote is possible, although given the omicron uncertainty we see it as less likely. Under either scenario, we think that sterling would receive an immediate leg up.In the event of no change in rates, investors will pay close attention to the bank’s comments on future hikes. A firm indication that a February rate increase may be on the way would support GBP, particularly should the MPC warn over the risks of above target inflation and talk up the strength of the UK labour market. Perhaps more likely, however, would be a relatively neutral, wait-and-see approach that leaves the door open to a February hike, without firmly committing to one. In this event, we would expect sterling to trade within a relatively narrow range versus its major peers. Either way, we still think that a February move in rates is coming, with an additional two or three hikes to follow during the remainder of 2022. This would likely be faster than most of the BoE’s major peers, and that should support the pound over our forecast horizon.👉 For more information on other special reports please see below:
