As expected, the Bank of England left rates on hold with one dissenter calling for a hike. On the whole it looks like a majority of policymakers are ready to hike if necessary but the bar for pulling the trigger has yet to be cleared. The bar for a hike is lower every day the crisis goes on, at least as far as the rate-setting MPC is concerned, but they seem at pains to make sure they don’t react too soon...as noted in past commentaries this was always going to be a messy one and signalling tricky. And sure enough we have enough different scenarios for inflation and views to not really know for sure what the reaction function will look like. I spy enough within the MPC who are not in a rush to raise rates, but the key test will be the pass-through to CPI numbers.
The hawkish chief economist Huw Pill wanted to hike rates to 4%, citing the risks of second-round effects in price and wage-setting stemming from the energy shock raising UK inflation beyond the near term in a persistent manner. I guess he thinks recession will kill off inflation.
The real question we wanted an answer to from this meeting was how close some of the others are to hiking and it seems the answer is ‘pretty close’, though some are nearer than others.
So it’s interesting to see where the individual MPC members are on this trade-off between inflation and the economy from their individual remarks in the statement.
Governor Bailey stressed that this is not 2022 and the softer real economy warrants a hold, and signalled a willingness to look through temporary rises in inflation: "If the shock appears to be short-lived or the economy weaker, policy should place relatively more weight on avoiding unnecessary contraction in activity."
The dovish Swati Dhingra seemed moved to suggest that it “may warrant some tightening” if the situation worsens. Most seem to favour tightening if inflation picks up, but the outlook is very cloudy.
Dave Ramsden thinks holding is appropriate for now and reckons second-round effects are “likely to be limited”. Catherine Mann “expects to increase” rates if inflation picks up. Claire Lombardelli said that “holding rates provides an appropriate degree of restrictiveness while we learn more about the scale of the shock and its propagation”.
The summary from the Bank noted that there is “a risk of material second-round effects in price and wage-setting, which policy would need to lean against,
However, policymakers noted that “the labour market continues to loosen, and a weakening economy could contain inflationary pressures”. Financial conditions have also tightened since the conflict began (ie bond yields have risen sharply) which the Bank thinks will help to reduce inflation over time.
Rate-setter Megan Greene noted: “For now, the yield curve has tightened enough to give us time to hold and learn, if not much about second-round effects soon then at least about the nature of the shock.” Alan Taylor similarly noted that “tighter financial conditions since the conflict began are amply restrictive to provide insurance against inflation”. Sarah Breeden likewise says there is “sufficient restrictiveness to guard against the current risk of second-round effects and gives us some time to learn more about the conflict and how it propagates”.
Those three plus Dhingra plus Bailey make 5 of the nine who are not as close to hiking as maybe the gilt yield curve implies. So, it all depends on how the data evolves.
The decision appears justified as no one knows how long the crisis in the Middle East and energy supply shock will last, nor crucially how it will feed into durable inflationary pressures. The bank is walking a tightrope with stagflation casting a long shadow.
At the last meeting (19/03) I noted that “the BoE didn't suggest further loosening is warranted and members are ready "to act as necessary" to ensure that CPI inflation remained on track to meet the 2% target in the medium term. Members said the next 6 weeks would be key to shed light on the duration and scale of the conflict and likely impact on inflation...that is by the next policy meeting on April 30th ... we could therefore assume that the Bank could be ready to hike at the next meeting if the conflict is still raging and energy markets still elevated..?”
The emphasis here is that they ‘could’ be ready – some on the MPC clearly are, but the majority remains in wait-and-see mode. The last meeting indicated even dovish policymakers were thinking about hikes and there was a hawkish repricing in gilt futures that Andrew Bailey pushed back against. I don't see how all that much has changed - the Bank of England ought to look through this temporary supply shock and wait a while longer before it thinks about thinks about raising rates. While inflation has ticked up due to motor fuel prices, we need more time to see the impact on broader inflation. Business surveys meanwhile paint a mixed picture with the Bank's own Decision Maker Panel not suggesting much pass-through. It will be harder for firms to pass on higher costs than it was in 2022 - the Bank risks fighting the last war. Governor Bailey seems aware of this risk.
While the Bank is mindful of inflation, I'd note that recent labour market data has softened and does not suggest second order effects of wage price spirals. This is not 2022 - the labour market is in a far worse place, workers lack the bargaining power they had then, rates are already restrictive not at the zero lower bound, and we don't have the huge post-pandemic demand impulse that unleashed prices and inflation expectations became unanchored.
GBPUSD moved lower post the announcement before pushing up further having ramped up against broad dollar selling ahead of the 12pm release – possibly month-end equity flows selling USD at work as well as the pressure on the USDJPY paring bleeding across the FX space with USD weaker. Japan's top currency officials were out giving 'final' warning on weaker JPY that broke the 160 level earlier. This gave JPY a bid having hit a high of 160.71. Officials hinting at green light from Washington to take necessary action if needed...USDJPY last a 155.20, down around 3%. This could just be the start of some big moves in JPY and will see increased FX volatility.
Cable here just showing potential bear cross on the MACD indicator after finding some relief at the 20-day SMA support
