BoE February Meeting Preview: Another split vote on the way

This Thursday’s Bank of England monetary policy announcement is a typically tough one to call, given the recent lack of consensus among committee members.

The MPC once again delivered mixed messages in December - a common theme throughout 2022. Rates were raised by another 50bps to 3.5%, the tenth consecutive hike, though the three-way split vote indicated that members were once again divided over the extent of additional tightening required. Two of the nine members, doves Tenreyro and Dhingra, surprisingly voted in favour of no change in rates, arguing that the bank rate was ‘more than sufficient’ to bring inflation back to target. The line from the November statement, which had pushed back against market pricing for UK rates was, however, omitted, in another apparent change of heart from the majority of the committee.

Since the December meeting, we think that macroeconomic news out of the UK has mixed ramifications for monetary policy though, on balance, we are pencilling in another 50bp rate increase this week. The focus among committee members clearly remains on inflation and, as of yet, we are yet to see clear evidence of a downward trend in either the headline or core CPI measures. One could argue that the surprise to the downside in the December UK inflation report has slightly taken the pressure off the MPC this week. In our view, this will not be enough to materially shift the hawks off course. Core inflation has remained particularly sticky, and has printed above 6% in each of the past six months.

Figure 1: UK Inflation Rate (2017 - 2022)

We suspect that the hawks among the committee will argue that this is not compelling enough evidence to begin winding down the hiking cycle, and that more needs to be done to ensure a return to the bank’s 2% inflation target. In our view, the BoE is not yet in the same boat as the Federal Reserve, which both tightened policy more aggressively than the MPC in 2022 (425bp vs. 325bps), and has witnessed clearer signs of a downtrend in domestic inflation. A likely point of contention and discussion among policymakers will perhaps be the recent signs of a deterioration in UK economic activity, most notably signs of weakness in retail sales and the services sector. This could lead to a few more dovish dissents among members, although again we do not believe that this will be enough to tip the balance in favour of a smaller hike, particularly as overall growth is proving rather resilient.

Figure 2: UK Key Macroeconomic Data [since 15/12/2022]

By contrast to the December meeting, financial markets are not yet fully accounting for a 50bp hike ahead of Thursday’s announcement. Another 50bp move is now around 80% priced in according to swap valuations, which we believe may perhaps be a consequence of interest rate repricing globally and the dovish vote and muddled communications among committee members in December. In the event of a half a percentage point move we do, therefore, see scope for a small rally in the pound, depending on the tone of the bank’s communications. A 25bp hike would be a fairly significant surprise for markets and, in our view, would likely trigger a rather sharp sell-off in the pound, regardless of how this is dressed up in the bank’s accompanying rhetoric.

Voting pattern key for GBP reaction

As always, the voting pattern among rate-setters will also be highly important in determining the market reaction. We are bracing for another three-way split among MPC members. We see no reason to suspect that members Dhingra and Tenreyro won’t again vote in favour of no change, as there has been little data out in the interim that suggests a more aggressive pace of hikes is required. Of the seven committee members that voted for a 75bp hike in November, all but Catherine Mann reverted back to a 50bp move in December - we think that she will follow suit on this occasion. That would leave seven votes in support of either a 25bp or 50bp move. Given the slight worsening in activity data, we could see a handful of votes for the former, though the majority (we think five or six), will likely throw support behind the latter. Any less than this may be perceived as bearish for the pound.

This week’s meeting will be a particularly important one for sterling, as the BoE will be releasing its quarterly Monetary Policy Report, including its updated economic projections, with governor Bailey’s press conference to follow soon after. We are pencilling in another upward revision to the 2023 GDP forecasts in light of more resilient domestic demand and lower energy prices. As we contested at the time, we thought that the November projections were far too pessimistic, a view that appears to have been vindicated by recent data. The updated inflation projections are also set to be closely watched. We think that a downward revision here is highly likely given the drop in UK natural gas prices (down 75% since late-August), which could indicate a less aggressive approach to rates ahead.

Dovish pivot on the way? Or stay the course for now?

Governor Bailey is unlikely to rock the boat too much during his communications on Thursday, and will probably again stress the importance of remaining data-dependent. In mid-January, Bailey hinted that current market pricing for rates, which had a peak base rate of around 4.5%, was about right. This would amount to either two 50bp hikes (including at this week’s meeting) or, more likely, back-to-back 25bp moves in March and May. We don’t think that Bailey will give any clear indication as to where rates could go after this week’s meeting, with the communications perhaps likely to remain tight lipped, while emphasising that the bank is taking a meeting-by-meeting approach.

Aside from any potential communications on rates, we will be paying particularly close attention to the bank’s view on both inflation and wages. UK earnings growth, at least in nominal terms, remains rather elevated, and the MPC may see the risk of wage-push inflation as heightened. Officials have recently stressed that the impact of last year’s rate hikes have not yet been reflected in the data, so markets will also be keen to hear when they expect this effect to be felt. Should the BoE indicate that it may soon pause its hiking cycle to assess this impact, then sterling could retrace some of its recent advances against most currencies, even in the event of another 50bp rate increase.