12 Dec 2016

MPC steady on Thursday, neutral rate bias maintained?

Philip Shaw

Chief Economist

The UK’s Monetary Policy Committee (MPC) will deliver its last monetary policy announcement of the year on Thursday 15 December at midday.

We very strongly expect this to be one of ‘no change’ with Bank rate held at 0.25% whilst the MPC continues to target a QE total of £435bn. The minutes and policy statement to that December meeting will also be published at the same time. We expect these to show the votes to hold Bank rate and QE totals steady as unanimous amongst all 9 MPC members.

The November Inflation Report and Governor Carney’s press conference pointed to a policy committee that was content with a neutral policy stance, no more or less likely to raise Bank rate as to cut it. In November the MPC set out its new forecasts pointing to inflation rising to a peak of 2.8% in Q2 2018 and remain up at 2.5% at the end of 2019, as the effect of the post-Brexit vote fall in sterling feeds through. We now view the Committee in an effective pause mode as it waits to see whether inflation rises broadly in line with its projections.

One question we have been asked frequently often over recent weeks is how much inflation the BoE would tolerate before it starts to seriously contemplate higher rates. There is no single point estimate answer and we do not expect the BoE to address this question head-on on Thursday. Perhaps though the minutes may provide some additional clues on how the MPC views price developments since November and the significance it places on market based measures of inflation expectations, which have risen markedly since the EU referendum. Indeed, we note that 5-year 5-year ahead breakeven yields hold around 3.58%, levels last seen in late 2013.

Our own view is that, for a sterling led inflation ascent, provided there remains limited evidence of higher inflation becoming engrained, the BoE would be willing to ‘look through’ inflation that is north of its own forecast and the 2% target; we think it would take a marked and persistent overshoot before the MPC decides it can no longer tolerate such inflation. In judging whether the BoE is getting closer to its tolerance limits over the next year, key metrics to track will include reports of major wage renegotiations, public perceptions of inflation expectations (which for 2-years ahead have now reached 2.5% (was 2.2% in August)) and of course pay growth outturns themselves. Note that the Bank has plenty of history of inflation ‘tolerance’ over recent years; indeed under Governor Lord King inflation peaked at 5.2% in September 2008 (and in September 2011) whilst the Bank of England was in a rate cutting mode. Furthermore, after the recent run of ‘lowflation’ we suspect the Bank is happy to tolerate a bit more inflation for a period, than risk sending inflation markedly lower again with a series of rate rises at a time when the economy is navigating its Brexit course.