BoE preview

Andrew Wishart, Senior UK Economist | |

BOE PREVIEW: TOWARDS A NOVEMBER HIKE Berenberg Macro View Backed into a corner: We agree with the Bank of England (BoE) that the latest spike in energy prices is un- likely to trigger a new price-wage spiral, but it would probably be a mistake for the central bank to argue that it does not need to hike. The tightening in financial conditions that the BoE says will help prevent per- sistent inflation is predicated on the central bank raising the policy rate. To keep this “insurance policy” in place, the BoE must deliver at least some of the tightening priced in (see Chart 1). Otherwise, it will fall be- hind other central banks and risk losing credibility. This would invite downward pressure on the pound that raises import prices and adds to inflation. The BoE can probably afford to keep its policy rate on hold at 3.75% this Thursday, 17 September. However, it will likely signal that it is moving toward a 25bp hike on 11 November, when it next publishes its Monetary Policy Report and holds a press conference. We expect a narrow vote of 5 in favour of a hold over 4 for a hike this week (consensus 6-3).

The jury is out: At this stage, we cannot know for sure whether the latest spike in global energy prices will trigger a broad-based acceleration in non-energy prices and wages that the BoE must snuff out by raising interest rates. Both inaction and hiking interest rates carry risks. So far, the BoE has proven reluctant to raise interest rates for fear of causing a downturn in employment. However, the renewed strangulation of energy exports from the Middle East will result in a more prolonged period of high energy prices that keeps the oil price at around $100 per barrel of Brent crude for the remainder of the year, in our view. Alongside increasing natural gas prices, this will push CPI inflation up above 3% yoy for the next six months at least. Meanwhile, solid GDP growth of 0.4% qoq in Q2 and 0.4% mom in July suggest that aggregate demand can weather a modest tightening of policy. We still think that the double squeeze on domestic demand from higher real economy financing costs and energy prices over the winter will prevent significant second- round effects. Nonetheless, the cost of raising bank rate by 25bp is small compared to the risk to the BoE’s credibility from delay. If we are right and energy prices decline in 2027 the BoE need not hike again and interest rate expectations will fall back, easing off the monetary brake. This and declining energy prices would support a reacceleration in GDP growth from 1.3% this year and next to 1.8% in 2028.

Tapering QT: The BoE is shrinking its balance sheet by not reinvesting the proceeds from gilts it owns ma- turing and by selling some government bonds back into the secondary market. Each September the Mone- tary Policy Committee (MPC) set the pace of quantitative tightening (QT) for the following 12 months. Last year, the MPC slowed annual quantitative tightening from £100bn to £70bn to limit active sales and reduce the risk of QT contributing to a deterioration of market functioning (see Chart 3). Less gilts that the BoE owns will mature over the next 12 months than the last. We thus expect the MPC to slow the pace of QT again this Thursday. A reduction to £50bn would keep active sales stable, and is the consensus forecast. Af- ter the selloff in government bonds over the past few weeks, if anything the BoE may reduce active sales a little further by announcing a smaller £40bn or £45bn reduction in the size of its balance sheet over the coming year.