The Bank of England and the search for clarity

Yesterday, the Bank of England (BoE) hiked base rates by 0.25%, taking these from 5.00% to 5.25%. This was very much in line with consensus expectations, with the majority of economists expecting a hike of 0.25%.

Having said that, there was some expectation the bank could move rates by 0.50%, given the recent strength of inflation data. As has been the case for some time, the committee was split on its vote; one member voted to leave rates unchanged; six voted for the hike of 0.25% and two called for a larger hike of 0.50%. This vote split justified market pricing ahead of the meeting, which suggested a 25% probability of a larger hike of 0.50%, and perhaps explains the market reaction that was fairly muted after the announcement; by close of business two-to-five-year gilt yields closed the day broadly unchanged.

With it being a monetary policy report (MPR) month, there was more data than usual for the market to digest. The BoE has been criticised by some market participants for its poor communication of late, and yesterday was no different, with the bank, somewhat confusingly, depicting how there were a number of different paths for interest rates that could bring inflation back to target within the forecast period. What was clear though was that the BoE stated – for the first time in this hiking cycle – that the base rates were now at a restrictive level. By implication, base rates should therefore be near to their peak. Today markets are pricing that rates will peak 0.50% higher than today at 5.75%, a somewhat lower peak than the 6.50% that was being priced in early July. Furthermore, the Monetary Policy Committee (MPC) stated that it “will ensure that base rate is sufficiently restrictive for sufficiently long time to return inflation to the 2.00% target sustainably in the medium term, in line with its remit.” Given that historically peak rates exist for 6-9 months, the market has interpreted this as peak rates being here for slightly longer than the historic average, with the first cut now priced for Q3 2024.

And finally, whilst the MPC did not explicitly state it was data dependent – as we saw from the US Federal Reserve and European Central Banks last week – it is evident the BoE now are too. For much of the last 18 months global central banks have been hiking in response to high and persistent inflationary pressures. Should this continue, the BoE will hike further. But rather than watching spot inflation, the market should increasingly start to focus on the labour market and wages. If inflation is falling, as it should be over the next few months, and there are signs of cracks in the labour market, wage pressures should start to dissipate, and the MPC will be on hold. The balance between inflation, wages, labour markets and growth will then determine the path from here. But that will be next year’s story.

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