BoE preview

Andrew Wishart, Senior UK Economist | |

BOE PREVIEW: TOUGH TALK, NO ACTION Berenberg Macro View Hollow threat: We expect the Bank of England (BoE) to leave its Bank Rate unchanged at 3.75% tomorrow, but threaten to raise interest rates if energy prices rise a lot more or evidence of second-round effects sur- faces. This provides a convenient insurance policy for the BoE: every time the Iran conflict flares up, inves- tors revise up their interest rate expectations and mortgage borrowing costs rise, immediately squeezing demand and reducing the risk of persistent inflation. Some analysts say that the BoE must eventually fol- low through on its threat for it to remain credible. Recent history argues otherwise – immediately after the 19 March BoE meeting, the market priced in two 25pb hikes to 4.25% by this week’s meeting. Neither has materialised, yet investors continue to price in two or three hikes. We do not think that the BoE will follow through with its threat to raise interest rates for two reasons: 1) Inflation in wages and services prices – the part of inflation that the BoE can best influence – continue to trend lower. 2) We think US President Donald Trump wants to avoid high oil prices because high petrol prices would damage the Republican party’s chances in the 3 November mid-term elections. If our reasoning holds, the BoE should turn more dovish over the remainder of the year, resume interest rate cuts in December, then lower the policy rate twice more to 3.00% in mid-2027.

Inflation undershoot ahead: CPI inflation of 2.6% yoy in June undershot the BoE’s last forecast, published in April, by 0.5ppt as lower food and core goods prices caught the central bank out. If the BoE uses its con- ventional observation window for market energy prices and interest rates, it will base the new forecast(s) on slightly lower oil prices and higher interest rates than before. As a result, the new inflation forecast should have a lower peak and undershoot the inflation target in late 2027. Historically that has been a sig- nal that the market path for bank rate is too high. In our forecast the combination of easing services infla- tion and a negative base effect a year on from the Iran-war increase in energy prices will lower CPI inflation to 1.6% in Q3 2027.

First round knockout: The BoE’s June minutes noted that the “appropriate response [to higher energy prices] would depend primarily on the outlook for second round effects”. The incoming data continues to support our view that slack in the labour market will prevent a new price-wage spiral. Our heat map shows that there is no indication of a reacceleration in wage growth in response to higher energy prices – see Ta- ble. Moreover, when the energy price shock faded in July, households were quick to lower their inflation expectations. Despite this, Megan Greene and Huw Pill will likely vote to hike rates again as insurance against potential second-round effects in the future, making it 7-2 in favour of a hold. As the squeeze on demand in H2 from higher energy prices and mortgage rates keeps labour demand and inflation subdued, we expect the two hawks to abandon their calls for a hike eventually. With the labour market flagging and the UK close to completing the return of home-grown price pressures to acceptable levels, we expect a ma- jority on the committee to vote for a cut by year-end.

Chart 1: Table: Berenberg inflation heatmap

Sources: Haver, ONS, BoE, Bloomberg, Citi/Yougov, Berenberg.

Disclaimer This document was compiled by the above mentioned authors of the economics department of Joh. Berenberg, Gossler & Co. KG (hereinafter referred to as “the Bank”). The Bank has made any effort to carefully research and process all information. The information has been obtained from sources which we believe to be reliable such as, for example, Thomson Reuters, Bloomberg and the relevant specialised press. However, we do not assume liability for the correctness and completeness of all information given. The provided information has not been checked by a third party, especially an independent auditing firm. We explicitly point to the stated date of preparation. The information given can…