No Major Surprises in (Possibly Final) BoE Hike, Inflation Worries Subside

• The BoE hiked 25bps as was largely expected by economists and markets in a 7-2 decision, with two members again voting for a pause.

• We think today’s hike will be the BoE’s last given the statement and minutes’ discussion of inflation set to undershoot the February MPR’s forecasts—thus not showing “evidence of more persistent pressures”.

• The BoE also removed its judgment that inflation risks remain skewed significantly to the upside. In fact, the communications are biased in the opposite direction, though this is clearly not stated.

• Markets may still be overestimating additional tightening in the pipeline from the BoE, and the path implied by UK swaps markets stands in jarring contrast to the sizable cuts priced in for the Fed. A correction of this divergence risks a widening of the US’s yield advantage over the UK, as well as downside in the GBP (though perhaps limited given undervaluation).

Today, the BoE increased its Bank Rate by 25bps to 4.25% in line with our expectation as well as the vast majority of economists and close enough to markets that had priced in 80–85% odds of a hike (with ‘insurance’ for a hold).

We think today’s hike from the BoE was its last (see latest forecasts), as we anticipate a steep decline in inflation starting in the second quarter of this year on the back of falling energy prices and an elevated base of comparison in year-ago terms—as well as the cumulative effect of the BoE’s 415bps in hikes since December 2021. Weakened real disposable incomes and depressed sentiment point to lower consumption this year, and high interest rates, uncertainty, and still high costs are bound to drive investment lower (with Brexit issues remaining a drag).

After February’s 50bps hike, the BoE voted to shift to a smaller 25bps increase today considering the tightening done to date as well as macroeconomic variables evolving roughly in line with their forecasts laid out in the February Monetary Policy Report.

The BoE’s guidance on additional tightening was left unchanged, noting that “If there were to be evidence of more persistent pressures, then further tightening in monetary policy would be required”.

It may have been Wednesday’s stronger-than-expected CPI reading (core at 6.2% vs 5.7% median) that pushed some officials in favour of another rate increase today, with seven voting in favour of a 25bps hike against two voting for a hold (Dhingra and Tenreyro, again). Of note, no BoE official (most notably, Mann) voted for a 50bps increase today.

Turning back to the BoE’s conditions for a hike, the decision minutes highlight that inflation is expected to fall significantly in the second quarter, undershooting their projection in the February MPR. The Energy Price Guarantee freeze at £2,500/annum as well as the freezing of the fuel duty and other Budget measures would account for a 1.33ppts lower headline inflation forecast in Q2 (i.e., just above 7% instead of 8.4%). Lower than forecast inflation would not meet the condition of “evidence of more persistent pressures”, in our estimation. Consumer and firm surveys have also seen lower rates of expected inflation, showing no obvious signs that expectations are becoming unanchored.

A highlight from today’s decision that supports the expectation of a hold at the next decision, amid optimism around the inflation path, is that the BoE removed its judgment that “risks to inflation were skewed significantly to the upside.” It appears that the BoE is comfortable with the prices outlook and the economy will not require additional tightening. On top of this change of view, the bank notes that “uncertainties around the financial and economic outlook had risen.” At the margin these should have some sort of hike ‘equivalence’ alike what the Fed’s Powell alluded to at the FOMC decision yesterday (when he equated an expected tightening of credit conditions to a 25bps increase “or perhaps more than that”).

The GBP originally strengthened against the USD to around intraday highs before falling to roughly unchanged at writing when compared to before the decision was announced; EURBGP initially chopped lower, but the EUR is now on net a touch stronger against sterling. Broad market moves seeing a choppy dollar and global yields make the action in UK markets in relation to the BoE somewhat difficult to discern, and SONIA contracts pricing for the next BoE decision mostly just incorporated the difference between the 25bps hike that the bank delivered and the ~20bps that were priced in this morning. On net, we think today’s decision was not favourable for Cable, and should provide relative support for gilts.

Broadly, it seems that UK yields and the GBP drove higher on the headlines before the details and a closer read revealed a rather dovish statement that points to a rate hold next month. But, there are a lot of data and developments to follow until then, so another rate increase cannot be ruled out though this is not our base case. Continued labour market strength would lead us to reassess our view to include another 25bps hike in May.

Still, we have trouble squaring the market’s expectations for an unchanged Bank Rate through year-end (maybe a 25bps cut from peak at 4.50%) in relation to about 75bps in cuts from the Fed’s market-implied peak (toss-up odds next month). This opens the door to some GBP weakness in the near-term (though the GBP has already priced in a lot of malaise) with the US’s yield advantage over the UK widening in the weeks and months ahead.