09 Mar 2017

MPC preview: Firmly on hold for now...

Philip Shaw

Chief Economist

The MPC will publish its monetary policy decision at 12 noon on Thursday 16 March. The minutes from the committee meeting will be published simultaneously.

Our firm expectation is that policy will remain on hold, with Bank rate unchanged at 0.25%, the target stock of assets under the QE programme held at £435bn and the target stock of corporate bond purchases held at £10bn. We also expect the committee to vote unanimously (9-0) in favour of an ‘on hold’ stance.

The meeting itself will take place in the immediate aftermath of significant global economic events. The day before (6pm UK time), we expect the US Federal Reserve to have raised the Fed Funds rate by 25bps, bringing the target range to 0.75-1.00%. In addition, the deadline for the US Congress to raise or re-suspend the government debt ceiling expires just after midnight (US time) on the 16th (05:01 UK time) – we expect the limit to be navigated without too much fuss but we would not rule out a political fight and associated market volatility. Finally, the Dutch general election will take place the day before (although full results will not be known until a few days afterwards). While these events are likely to dominate market sentiment, the MPC might offer some interesting titbits on the UK rates outlook.

At the last MPC meeting on 2 February, accompanied with the quarterly Inflation Report and press conference, the MPC set its stall out firmly to an ‘on hold’ stance. Given the UK economy’s surprising resilience since the EU referendum, the MPC upgraded its economic growth forecasts materially (GDP is forecast to grow by 2.0% this year, versus a forecast for 1.4% growth three months previously). At the same time though, the committee lowered its estimate of the ‘equilibrium’ unemployment rate from 5.0% to 4.5%. That means that the committee reckons that the jobless rate (currently at 4.8%) can fall even further before pushing up on wage inflation.

So, despite the growth forecast upgrade, such a sanguine view of domestic inflation pressures came across as dovish and market rate expectations flattened – markets do not expect a hike for about another three years. The MPC does see the headline rate of inflation climbing well above the 2% target over the next couple of years, but the ‘overshoot’ is expected to be driven entirely by the effect of falls in sterling on imported inflation, which can be ‘looked through’ as a temporary phenomenon.

Since last month’s Inflation Report, we note two (modest) pieces of news relating to the real economy. First, GDP growth in Q4 last year has been revised up from +0.6% to +0.7% q/q, pointing to even more post-EU referendum momentum than previously thought. But, second, indicators referring to the start of this year, most notably last month’s retail sales numbers, are pointing to the likelihood that rising inflation is beginning to squeeze household real income and spending. For that reason, the MPC is very likely to stick with its view that the economy is set to slow down soon and that domestic inflationary pressures will remain in check. Besides its interpretation of this news, we will also be interested to see the MPC’s snap reaction to the (almost certain) US rate hike. But we do not think this will have a first order bearing on the policy decision at Threadneedle Street.

Looking forward, the one thing that might shift the MPC (in a more hawkish direction) is if the prospective rise in inflation turns out to be larger and/or more persistent than it currently expects. That might be the case if the effect of higher imported inflation spills over into higher inflation expectations, putting broader upward pressure on wages and prices. But even if such a scenario does materialise, we are still a long way from observing it.

We broadly share the MPC’s sanguine view about domestic cost pressures, while we also acknowledge the risk of a rockier-than-expected road to Brexit creating economic headwinds. For that reason, we maintain our central view that there will be no increase in Bank rate until Q4 2019, where we are forecasting a 25bp hike. We will be very surprised if we see anything next Thursday to lead us to change that view.

Finally, we note that next Thursday’s meeting comes at a key milestone. By then, the £60bn boost to the QE programme announced last August (to bring the total asset stock to £435bn) will be complete. The minutes might allude to that fact. In terms of market implications, we would not rule out a touch less downward pressure on gilt yields as a key guaranteed buyer exits the market. The corporate bond purchase scheme continues, though – the stock of purchases here is currently touch shy of £8bn so it will still take some time for the £10bn target to be met.