Bank of England: paused - for now

The economist view – Melanie Baker, Senior Economist

BoE: Pause but still on track for a November cut

As expected, the Bank of England (BoE) kept rates on hold at 5.00%. Despite only one out of nine MPC (Monetary Policy Committee ) members voting for a rate cut today, I think it still seems reasonable to expect another rate cut in November (I have pencilled in a 25bps cut). On quantitative tightening (QT), the BoE announced that they will reduce the stock of gilts by £100bn over the next 12 months. That implies a reduction in the pace of active sales (£87bn would be maturing bonds).

Gradual rate reduction expected

The BoE see the activity and inflation data as having come in roughly as expected: “There had generally been limited news in UK economic indicators relative to the Committee’s expectations in the August Monetary Policy Report." Their existing set of forecasts (published in August), which saw inflation get back to target in two years, were based on a profile for rates that fell relatively gradually down to 3.50% in three years’ time. Their language (and the 5-4 vote) at their August meeting  did not suggest that they were in a big hurry to cut rates either and that remains the case with the minutes today: “For most members, in the absence of material developments, a gradual approach to removing policy restraint would be warranted.”

November makes more sense for the next cut

In November, they will have an updated set of forecasts and analysis. Having made a move towards scenario analysis (which seemed to weigh on their thinking in August and again features in today’s minutes), it makes sense that they would want chance to fully refresh that again before cutting. Meanwhile, there is an absence of data suggesting that the UK economy is seriously turning down and that the Bank therefore needs to move quickly. Much of the UK activity data has held up well, including relatively robust PMI business surveys and a fall in the unemployment rate. However, in line with them cutting further in the months ahead, on the unemployment rate, they note in the minutes that it was very difficult to gauge the underlying state of labour market activity given data quality issues and that their own model suggested that “underlying unemployment had increased steadily over the past few quarters.” They also note further evidence supporting a moderation in pay growth for example.

Some risk of a delay though

Still, if the activity data continues to hold up as it is and with inflation a bit above target (and expected to rise into year-end on a rise in energy bills), there must be a chance that the next move is in February rather than November. They note, for example, that a continuation of the current pace of underlying GDP growth would imply less spare capacity opening up in the economy than they had forecast. They also note that their forecast for spare capacity  “in part reflected the previously announced medium-term tightening in the stance of fiscal policy”. A stimulative Budget could knock their forecasts even further off course. 

there must be a chance that the next move is in February rather than November

The government bond manager view – Ben Nicholl, Senior Fund Manager

The September meeting saw the BoE vote by 8-1 to leave interest rates on hold at 5.00%. This was despite the Fed firing the starting gun on its rate cutting cycle with a full 0.50% rate cut the day before. At the last meeting Governor Bailey had emphasised that the MPC was in no rush to cut rates hard and fast. With certain elements of inflation remaining sticky, labour markets still relatively tight, and the upcoming budget on 30 October, this approach looks prudent. The market only had a 20% probability of a 0.25% cut priced, so was largely expecting no change – although the market was perhaps expecting two members of the committee to vote for a rate cut rather than the single dissenter. A 25bps rate cut later in the year in November, however,  is fully priced and the market will be paying close attention to the economic data as well as the actions of other central banks to determine whether a further rate cut is warranted.

A 25bps rate cut later in the year in November, however, is fully priced

The market was also paying close attention to what the BoE would announce with respect to its QT programme. For the last few years, the BoE has been undertaking QT by allowing the UK gilts it owns to mature without re-investing the maturity proceeds (often called Passive QT), and by actively selling bonds back to the market (Active QT). Each September the BoE reviews the QT program for the next 12 months. For the last few years, the BoE’s ownership of bonds has reduced by around £100bn per annum. At today’s meeting the BoE decided to maintain the pace of QT at 100bn pa, but with £87bn of this coming from Passive QT, the BoE’s footprint on the gilt market will be significantly reduced; this means only £13bn of active sales for the next 12 months, which is a significant reduction from the prior year. Based on comments in the minutes, the barrier to altering the annual pace of £100bn appears high.

The immediate market reaction has seen yields largely unchanged, particularly in shorter maturities. That’s of little surprise given what was expected and priced by the market. However, with the committee once again emphasising that rates may need to remain higher for longer, the market may need to reassess just how many rate cuts it has priced in for the next 12 months.

This is a financial promotion and is not investment advice. Past performance is not a guide to future performance. The value of investments and any income from them may go down as well as up and is not guaranteed. Investors may not get back the amount invested. Portfolio characteristics and holdings are subject to change without notice. The views expressed are those of the author at the date of publication unless otherwise indicated, which are subject to change, and is not investment advice.