30 Jan 2017

MPC preview: A (slightly) more hawkish bias for Bank rate?

Philip Shaw

Chief Economist

The MPC announces its policy decision this Thursday (2 February). This will be accompanied by the publication of the minutes of the policy meeting and the February Inflation Report, containing the committee’s latest macroeconomic projections. Then at 12:30pm, Governor Mark Carney takes the stage at the usual quarterly press conference on monetary policy.

We expect the MPC to vote unanimously for no policy changes this month. Therefore we see Bank rate remaining on hold at 0.25%, the target stock of assets held under the QE programme remaining at £435bn and the target stock of corporate bonds held at £10bn. In particular, the MPC might note that the latest batch of QE purchases and purchases under the corporate bond programme are likely to be wrapped up within the next couple of months.

The MPC is likely to upgrade its growth forecasts. Back in August, the MPC launched a ‘package’ of stimulus measures to guard against a post-EU referendum slowdown in the economy. This included a Bank rate cut from 0.50% to 0.25%, a restarting of the QE programme, the introduction of corporate bond purchases and the launch of the Term Funding Scheme (TFS). Back then, the MPC’s forecast for GDP growth in 2017 was a measly +0.8%. But then, with the data pointing to businesses and households shrugging off Brexit-related uncertainty, the committee decided in November to upgrade its 2017 growth forecast by more than half a per cent, to +1.4% (admittedly, while also nudging down its view of growth beyond that). Rolling forward to today, the data have continued to surprise to the upside, with GDP growing by a solid 0.6% in the third and fourth quarters of this year. And since November, we have upgraded our own 2017 growth forecast from 1.4% to 1.7% – we would not be surprised if the MPC broadly follows suit.

With such a mild growth slowdown in prospect, the economy would still be running at close to full capacity. If the MPC revises up its GDP growth forecast to anywhere near 2% for this year and next (the growth rate seen in 2016), that would indicate enough economic resilience to avoid much of a rise in unemployment. Indeed the jobless rate currently stands at a healthy 4.8% and we only anticipate an increase to around 5½% by the end of 2018. More broadly, we do not anticipate a very wide (negative) output gap opening up over the next couple of years. If the MPC’s forecast ends up looking similar to ours, that would take the rationale for any further policy loosening well off the table.

The MPC will continue to predict a substantial (sterling driven) inflation target overshoot. In November, the MPC predicted that the rate of CPI inflation would peak at 2.8% in the first half of 2018, as the weaker pound pushes up on imported inflation. There is a chance that, even with a somewhat stronger growth outlook, Thursday’s inflation forecast will be a touch weaker than last time, given the 3% rise in sterling seen since then. But even so, the pound still lies over 12% below its immediate pre-referendum level, in trade weighted terms. That is still likely to deliver a significant overshoot of the MPC’s 2% inflation target over the next 2-3 years.

We suspect the MPC will offer a slightly more hawkish steer on Bank rate. In November, Mark Carney conveyed a ‘neutral policy bias’, which we interpret to mean that the MPC saw itself as just as likely to rate rates as cut them. But, given the prospect of only a mild slowdown in the economy, alongside the continued prospect of above-target inflation, our own view is the next Bank rate move is more likely to be up than down. While we see the MPC willing, for now, to ‘look through’ the transitory inflation overshoot (sterling effects are unlikely to last for more than three years) and lingering Brexit-related risks, our central view is that Bank rate will not rise until late-2019. But to the extent that the MPC sees the outlook similarly to us, we might see at least a subtle shift in focus away from a ‘neutral bias’ to a slightly hawkish one.

Specifically, there is a chance that the MPC will quietly ‘endorse’ the upward-sloping market rate path. We note that the OIS forward curve (the Bank rate expectation on which the MPC’s forecast is conditioned) rises from 0.25% to 0.9% by the end of the published forecast horizon (March 2021), which would be consistent with two, possibly three, Bank rate increases. If the MPC does not explicitly ‘push back’ against this expectation, that might signal an endorsement of the view that rate rises are more likely than rate cuts.

Brexit, Trump and ‘Michael Fish’ moments might all provide press conference entertainment. At the press conference, we have little doubt that Governor Carney will be questioned on the latest developments on Brexit and the presidency of Donald Trump. On Brexit, we now know from Theresa May that the UK is set to leave the Single Market. While that poses a headwind to the UK economy, we reckon that the BoE would have drawn that conclusion already, so we expect little change as a result of this. Meanwhile, there will no doubt be questions asked about the implications of the Trump Presidency for the UK economy, but we doubt this will have first order implications for the MPC’s policy outlook. Finally, we note that journalists might raise BoE Chief Economist Andy Haldane’s mea culpa this month, where he admitted that the 08/09 financial crisis was a ‘Michael Fish’ moment for economic forecasters – in contrast, we expect the Governor to defend the integrity of the MPC’s forecasts, while stressing the uncertainty that lies around them.