15 Dec 2016

MPC reaction: A neutral policy bias, but with a slightly hawkish undertone?

Philip Shaw

Chief Economist

The MPC voted unanimously to keep policy on hold this month, as universally expected by economists. As such, Bank rate was maintained at 0.25%, the target stock of asset purchases under the QE programme was held at £435bn and the target stock of corporate bond purchases was remained unchanged at £10bn.

Since the MPC’s announcement to hold policy at the time of its last Inflation Report on 3 November, the meeting minutes reported on a set of developments that broadly balance out, from a monetary policy perspective. The main news discussed was as follows:

  • The Committee noted that long-term interest rates have risen globally since the US election. Members seemed fairly sanguine about what amounts to a tightening in financial conditions, opining that the rise in rates reflects (i) the possibility of looser US fiscal policy under Donald Trump (ii) a reduction in the risk of persistently low inflation (iii) a slightly greater degree of economic momentum in the global economic data. As such, the MPC reckons that near-term global prospects have improved somewhat.

  • However, this marginally more bullish central case is tempered by a view that global downside risks have increased. In particular, and piggybacking off the Financial Stability Report (published 30 November), the MPC pointed in particular to risks of disorderly capital outflows from China and other emerging markets as US rates rise.

  • On the domestic data front, the MPC saw nothing game changing. The Committee noted the continuation of ‘remarkably stable’ growth through 2016 and saw ‘healthy’ labour demand over the second half of the year. Nevertheless, other demand and output indicators still suggest, in the MPC’s view, a slowdown in 2017, particularly as higher inflation begins to squeeze household real incomes. On the inflation front, there was also little news, with November’s CPI inflation rate in line with the Inflation Report forecast, at +1.2% y/y.

  • Finally, the minutes noted a 6% rise in sterling, in trade weighted terms, since the November forecast was published. This would imply ‘somewhat less’ of an inflation overshoot than implied by the November forecast (which saw CPI inflation peaking at 2.8% in mid-2018).

Despite the possibility of a more muted inflation outlook, given recent sterling moves, the tone of today’s minutes seems to convey the continuation of what Governor Mark Carney last month called a ‘neutral bias’ for monetary policy. The MPC still sees itself facing a balancing act between slower economic growth (and higher unemployment as a result) and above-target inflation and that monetary policy ‘could respond, in either direction, to changes in the economic outlook as they unfolded’.

However, we would note that at no point in the minutes does the MPC push back on market pricing for Bank rate. The OIS forward curve (on which the Committee bases its economic forecasts) has steepened somewhat since November. It now points to at least one 25bp rate hike and a 50:50 chance of a second hike by 2019 Q4. The November Inflation Report path suggested a 50:50 chance of just one 25bp hike by then. Granted, no rate rises are fully priced in until the start of 2019 and we maintain our view that there will be no rate changes until at least the end of 2018. But to the extent that the MPC endorses market pricing, and crucially, if major Brexit risks fail to materialise, there might be just a glimmer of hawkishness to the ‘neutral bias’.