BoE preview: Hawkish hold, emphasis on higher for longer

All talk, no action

The Bank of England’s (BoE) nine-member Monetary Policy Committee (MPC) meets this week against a backdrop of softening economic momentum and fading, but still too high, price pressures. Following the finely balanced decision to pause its rate hike cycle at 5.25% at the previous meeting in September, we look for theBoE to remain on hold again on Thursday. The BoE has lifted the bank rate from 0.1% in December 2021. As inflation has eased somewhat faster since June than the BoE had anticipated (Table 1), policymakers have a solid rationale to hold off from any further tightening and signal that no more hikes should be needed so long as inflation continues to trend lower. Our call for a hold is in line with the overnight index swaps (OIS) market, which puts just a 6% chance on a rate hike.

The BoE will publish its decision at 12:00GMT on Thursday followed by a press conference with governor Andrew Bailey at 13:00GMT.

Now that the tightening phase of the policy cycle is probably over, the key questions for markets are: 1) for how long will the BoE keep the bank rate at its current restrictive level; and 2) how much will the BoE cut rates when the time comes?

Expect the BoE to drill the message that policymakers intend to keep the bank rate ‘high for longer’. But we need to be careful when interpreting such guidance. In our view, this aspect of the BoE’s guidance is a policy tool in itself rather than a genuine forecast. If markets believe the ‘high for longer’ mantra, and judging by money market rate expectations they do, this verbal tool can prevent money market rates from falling too low too quickly in anticipation of eventual rate cuts. That helps the BoE, as it prevents a premature easing of financial conditions. It probably also explains the large gap between our own bank rate calls for next year and what is currently priced into OIS markets. Whereas we expect bank rate to finish 2024 at 4.0% with five 25bp cuts starting in Q2, the OIS market currently prices in just one 25bp cut to 5.0%. Given the OIS market’s poor track record of forecasting the path of bank rate (Chart 1) we should be cautious about placing too much weight on it as useful guide to future policy and instead consider what is more likely for the bank rate outlook based on economic fundamentals and historical experience.

BoE economic forecasts – softer near-term, modest upgrades thereafter

In August, the BoE projected 0.5% yoy gains for real GDP in each 2023 and 2024 followed by a meagre 0.3% rise in 2025. This compares to our own calls of 0.5%, 0.7% and 1.7% and Bloomberg consensus expectations of 0.4%, 0.4% and 1.3%, respectively.

For 2023, the BoE is unlikely to change its call much. A likely boost to the annual growth rate coming from upward revisions to H1 2023 data since the August forecast round is offset by likely downgrades to the bank’s updated Q3 estimate and projection for Q4. In August, the BoE forecast growth of 0.4% qoq growth in Q3 and 0.2% in Q4. The BoE had already warned in the September meeting minutes that Q3 would be lower than expected in August (with a downgrade to a 0.1% qoq rise). Judging by recent data disappointments, including the PMIs (Chart 2), H2 is likely to be closer to flat over the two quarters. We look for real GDP to decline by 0.1% qoq in Q3 before flatlining in Q4. Risks to our near-term calls are tilted to the downside.

For 2024 and 2025, we expect modest upgrades to the BoE’s projections due to the fact that the updated monetary policy assumption will be for a lower bank rate path compared to August (Chart 3). In its forecasts, the BoE uses the OIS curve as its conditioning assumption for the path of the bank rate. The November forecast will be based on a bank rate peak of 5.25% – some 75bp lower than in August – with an average of 4.7% through to the end of 2026 (60bp lower than in August). Because monetary policy works with a lag, this change will likely lead to a larger upgrade to GDP growth in 2025 than in 2024. Nevertheless, the BoE’s updated projections are likely to remain below ours and Bloomberg consensus since market economists (including us) expect more bank rate cuts through 2024 and 2025 than are implied by money market prices.

The OIS market prices in that the bank rate will fall to 4.9% by the end of 2024 with a further modest decline to 4.4% by the end of 2025. We look for the BoE to cut the bank rate to 4.0% and 3.0% by the end of 2024 and 2025, respectively. Our call is c50bp below the Bloomberg consensus of economists at each year end – which also partly explains our above consensus calls for real GDP.

Data dependent with a hawkish bias

Will the 5-4 vote split in September be repeated at this week’s meeting? Unlikely, in our view. While the most hawkish MPC members – external members Jonathan Haskel and Catherine Mann – are likely to stick with their previous votes for a further 25bp hike, we expect a greater majority to back ‘no hike’ at the November meeting. That would further solidify market expectations that the BoE rate hike cycle has reached its end.

However, as inflation is still more than three times above the BoE’s 2% target, we expect the minutes and guidance to project a decidedly hawkish tone. While policymakers are likely to re-emphasise that the current stance of monetary policy is ‘restrictive’, which de facto removes the need for further bank rate hikes so long as inflation trends down, they will likely keep the previous meeting’s guidance that ‘further tightening in monetary policy would be required if there were evidence of more persistent inflationary pressures’. Judging by the gap between offered and effective mortgage rates (Chart 4), probably less than half of the BoE’s tightening that started in October 2021 has actually passed through into the real economy so far. The UK thus faces many more months of de facto policy tightening to come even after policymakers have stopped raising the bank rate.

In September, policymakers stated that they would be paying special attention to tightness in labour markets and wages as a potential source of persistent inflation pressures. Although current wage growth which seems to be levelling off at near-8% yoy (Chart 5a) is perhaps twice what is sustainable to keep inflation stable at 2%, emerging labour market slack as vacancies fall and unemployment edges higher (Chart 5b), as well as falling inflation expectations (Chart 2b), all point to weakening wage growth over coming months.

For a critical analysis of the BoE’s forecasting and communication framework, please see our note ‘BoE: a new framework to close the credibility gap’

Chart 1: Bank rate assumption at BoE forecast rounds

Based on overnight index swap (OIS) curve. In %. Red line shows actual path of BoE bank rate. Quarterly data. Source: BoE

Chart 2: UK purchasing managers indexes

50+ = expansion. Monthly data. Source: CIPS, SPG

Chart 3: Bank rate assumption down significantly since August

Overnight index swaps forward curve. MPR: Monetary Policy Report. In %. Quarterly data. Source: BoE

Chart 4: BoE bank rate and mortgage rates

In %. Monthly data. Source: BoE

Chart 5a: Estimates of UK nominal pay growth	Chart 5b: UK unemployment rate versus vacancies
% yoy. Average weekly earnings based on Labour Force Survey. Median monthly pay based on PAYE experimental data. Monthly data. Source: ONS, Indeed	Vacancies in millions. Monthly data. Source: ONS

Kallum Pickering
Senior Economist, Head of ESG & Data, Director

Mobile +44 791 710 6575

Phone +44 203 465 2672

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