The Bank of England raised UK interest rates for the first time in more than 10 years, with a 25bp rise in Bank rate enacted. That was in line with broad expectations and our own view. Other elements of policy were left unaltered with the QE total held at £435bn and the Corporate Bond buy total at £10bn. There were two dissenting votes on the decision to raise Bank rate with those coming from the two ex-Treasury appointees, Sir Dave Ramsden and Sir Jon Cunliffe. That 7-2 (hike-hold) vote on Bank rate was also broadly in line with market expectations and matched our view.
With the Bank rate hike, largely anticipated, one key question for BoE watchers was whether the Monetary Policy Committee (MPC) would signal that today’s move was either:
- A standalone hike and then a pause (i.e. one hike and done)
- The start of a gradual tightening path, or
- The start of a more active tightening path (i.e. steeper than the market path).
A look at the Inflation Report projections published today points to a view where the market path for rates, on which the BoE numbers were conditioned, results in inflation still running a bit above target at the end of the forecast period. Indeed, with two further hikes pencilled in over the next two years, the BoE still sees inflation at 2.15% in three years’ time. As Governor Carney said in his press conference today, “inflation doesn’t quite get there” [i.e. to target] with two rate rises. Taken at face value, this might imply a slightly steeper path for rates than the market curve was pricing in, ahead of today’s meeting.
Importantly for markets, however, Governor Carney did not give an explicit steer, as he did in August, that more hikes than financial markets expect could be needed. Furthermore, he even said that ”broad brush” market pricing gets you broadly where you want to be, whilst stressing again the need for rates rises to be gradual and limited. We note that the market path for rates on which the August forecasts were conditioned was flatter than the assumptions today’s projections were based on, partly explaining why the Governor felt less need to nudge expectations.
‘The most likely reason to adjust Bank rate in either direction, would be some resolution of big issues around Brexit.’
When considering the path for rates here forward there also appeared to be a Brexit overlay to apply to any analysis of the appropriate path for rates, given that it is not possible to fully reflect Brexit uncertainties in BoE projections. When asked about a possible policy U-turn (i.e. a later reversal of today’s hike), Governor Carney said that the most likely reason to adjust Bank rate in either direction, would be some resolution of big issues around Brexit. The potential important implication of the above statement is that the MPC would await further clarity on some key elements of Brexit arrangements, before enacting its next rate move. If correct, this might imply that the next move in Bank rate is far from imminent. We also note that, in amongst Governor Carney’s efforts to skirt around any “political” questions on Brexit, there appeared to be a more cautious tone on Brexit generally. This is perhaps most easily evidenced in the six mentions of the word Brexit in the November meeting minutes (zero in the September ones) and the three mentions of uncertainty in the November meeting record, against none in September’s minutes.
For sterling, the above points were enough to leave the market pondering the possibility that this could, quite possibly, be one rate hike and done, at least for a good amount of time. Indeed, we note that the Bank of England’s trade weighted sterling index was down 1.3% on the day, following what has widely been interpreted as a dovish BoE policy steer. We take on board the Governor’s steers on the need for Brexit clarity, but we still suspect the BoE will push ahead with a couple of hikes over the coming years, not least because the Committee seems genuinely concerned about the lack of remaining economic slack and the threat that implies for inflation down the road.
Governor Carney described a deliberation over how to deal with the growth and inflation trade off, given the “exceptional circumstances” of Brexit. The Governor flagged the tightness of the labour market and described in considerable detail the various indicators that pointed to pay growth being on the rise. One key focus for the BoE was its own Agents’ Survey which the Governor said had correctly predicted the lack of a pick-up in pay growth this year and was now pointing to growing pay growth momentum for 2018. Furthermore, the Governor explicitly stated that the BoE was “running out of road on labour supply”. Overall, Dr Carney presented a picture of a MPC that, bar the two dissenting voices of Sir Jon Cunliffe and Sir Dave Ramsden, was seriously taking note of the lack of spare capacity in the economy, with the unemployment rate at a 42-year low of 4.3%.
We continue to suspect that we will see a further rate rise from the BoE next year. We are less convinced than the BoE that pay growth will gather steam (at least as rapidly as the BoE envisages) and that a material pick-up in domestically generated inflation is on its way. But our reading of the BoE’s concerns here lead us to believe that the MPC will not be totally comfortable holding policy steady for a sustained period of time. For now, and of course pending developments on the Brexit front, we continue to suspect that we will see a further rate rise from the BoE next year.
Finally, we note that, having enacted the first rate rise in over a decade, Governor Carney was keen to show that the Bank had done its homework and was comfortable that households would be able to manage this. Indeed, the Inflation Report cites various statistics on this, not least that the share of fixed rate mortgages by value has risen to around 60% of the stock of mortgages. Furthermore the report highlights that past falls in interest rates might mean that some mortgagors would move onto lower rates than previously, when their fixed rate products expire. Part of the ethos behind today’s cautious approach to the BoE enacting its first hike in over a decade, is likely to be because the response of households to the rate rise is an open and uncertain question. If households are seen to be managing this, this will only serve to reinforce talk of further policy moves ahead as the BoE is able to hone in further on its inflation target.