- The Bank of England met our, the economist median, and the market’s expectation with a 75bps hike today. However, the set of communications hit the GBP and short-term UK yields on weak economic forecasts and a firm push-back against market pricing.
- Yesterday, the Fed told markets to expect a higher terminal rate than they had guided. Today, the BoE went in the other direction and implicitly asked for a lower terminal rate.
- Our latest forecast that sees an end-2022 policy rate at 3.75% may currently be overshooting by 25bps, with our terminal rate projection of 4.50% also facing a 50bps downside risk.
The Bank of England met our, the economist median, and the market’s expectation with a 75bps hike today. However, the set of communications hit the GBP and short-term UK yields on weak economic forecasts and a firm push-back against market pricing.
Yesterday, the Fed told markets to expect a higher terminal rate than they had guided. Today, the BoE went in the other direction and implicitly asked for a lower terminal rate than the 4.50–4.75% priced into the OIS curve. The GBP extended its losses on the Fed’s decision from an intraday high of ~1.1565 yesterday to as low as ~1.1155 this morning around Gov Bailey’s press conference. It has since recovered to near 1.12 but remains severely damaged.
The three-quarter point BoE hike was not enough for markets seeking not only more hawkish guidance but also a strong encore act to the hawkish Fed. UK 2-yr yields are net 2-3bps lower on the day but around 7–8bps lower than ahead of the decision this morning.
In the bank’s projections that incorporate a peak policy rate of 5.25%, the UK economy enters into an eight-quarter recession and inflation falls significantly below target and stays there until the end of the forecast horizon. Put another way, the bank is sending a message that it will not be able to meet the market’s expectation as that would see a severe undershooting of inflation beginning in Q2-2024. Even a projection that includes a constant bank rate at 3% sees a period where the economy contracts by five out of six quarters—reflecting the need for the bank to bring the UK economy back in line with fundamentals, as well as the negative impact of the country’s cost of living crisis.
At the press conference, Gov Bailey said that the best guess for the rates path is a constant rate of 3% instead of the market’s pricing. While the bank’s officials have clearly noted that more rate hikes are likely, they have warned about markets maintaining the currently-implied pace of hikes. Bailey and the two deputy governors by his side (Broadbent and Ramsden) noted the undue pressure that these elevated market rates were placing on mortgage rates that priced off these instruments. In this way, the bank expressed worries about mortgage serviceability and the stability of the country’s housing market (not too differently from the BoC at its decision last week).
The bank’s Monetary Policy Committee was not unanimous in its decision, with seven in favour of 75bps, two in favour of 50bps, and one in favour of 25bps. The split vote and the fact that Tenreyro (a relatively influential dove) preferred a smaller increase suggest that the December decision will be divided across a 50bps or a 25bps increase.
There was little in today’s decision statement, Monetary Policy Report, nor the press conference to suggest that the BoE will opt for another three-quarter-point increase next month. Another big hike may add fuel to the fire of market expectations and go against the bank’s goal to veer swaps markets towards a lower ceiling. A steadying fiscal picture has also taken pressure off the BoE to fight the inflationary pressures of the now-defunct mini-budget. In fact, incoming measures may be net deflationary in comparison to the pre-mini-budget picture. If Chancellor Hunt and PM Sunak announce an ‘austerity-light’ fiscal plan around mid-month, the BoE may even sound a more optimistic tone on inflation—meaning market bets will be due for another haircut. There are a lot of moving parts to today’s decision from the BoE that require careful analysis to nail down expectations for its December meeting; inflation data out on November 16 will also play an important role.
Despite the Governor’s message today, markets remain well overpriced in their projections for the BoE’s rate. At 4.50–75%, the peak terminal rate seen in OIS markets may be overshooting by as much as 75bps—though incoming data will determine whether markets are on the right path. In fact, markets oddly are net higher in their expected BoE terminal rate today, though this may reflect erratic trading conditions in swaps rather than traders actually adding to their hawkishness.
Our latest forecast that sees an end-2022 policy rate at 3.75% may currently be overshooting by 25bps, with our terminal rate projection of 4.50% also facing a 50bps downside risk. A combination of factors such as wholesale energy prices holding their weakening trend, the government’s fiscal plan proving net negative for inflation, the trade-weighted value of the GBP, and the recessionary depth of the UK economy, etc. are among a number of risks opening up a wide range of possibilities for the BoE rate path.
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