Bottom line: The latest 25 bp BoE hike to 4.5% came amid very much unchanged policy guidance with no explicit pointer to a rate peak having been reached. Moreover, a risk of food prices remaining high, a 2 ppt-plus cumulative GDP growth upgrade, and what it perceived to be a firmer economic backdrop of late partly explains the BoE’s much less soft medium-term inflation outlook. In addition, despite accepting still elevated uncertainties around the global financial and economic outlook, the MPC still stresses that developments on UK domestic credit conditions areas expected to be small. At the same time, the inflation outlook which embraces the upside price risks that the MPC majority see still points to inflation at or below the 2% target (Figure 1). This implies that that there is no inherent tightening bias, rather an inclination that further hikes are still possible if price data suggests more persistent pressures. But we still see this hike being the final move and the BoE over the summer will likely become more concerned around growing downside risks we feel important emanating from weakness in monetary data, (Figure 2). Indeed we still see BoE rate cuts next year!
Figure 1: Inflation Back to Target?
Source: BoE, CPI projection n May MPR
BoE Upgrades Growth Outlook
In providing a 12th successive hike, again matching the smaller 25 bp increase delivered in March, the BoE took Bank Rate to a fresh 15-year high of 4.5%. The Monetary Policy Report (MPR) highlighted a better immediate and medium-term growth outlook (encompassing a 2 ppt-plus cumulative GDP growth upgrade) behind this latest, albeit with the level of GDFP still seen being weak and fragile. Moreover, there two dissents against any hike and these even hinting at a policy reversal. Regardless, there is no explicit pointer to this being a peak in the hiking cycle, as the inflation projections showing a drop to well below target is seen as having marked upside risks.
These risks are based particularly around more persistent wage pressures and food price inflation, with BoE Bailey noting the bias among most MPC members towards the mean which encompasses the upside risks in Figure 1 rather than the traditional mode forecast. They may very well not materialize: there are increasing signs that the labor market is loosening while food price pressures are likely to be supply driven and may only exacerbate the recent erosion in spending power, thereby also helping curb pricing power which the MPC does admit may be reflective in padded out company profit margins.
Monetary Downside Risks
In addition, we would underscore that there are also added downside risks that we feel the BoE is underestimating, most notably in what is happening in terms of monetary data. Indeed, we think that domestic credit conditions are tightening more than the BoE accepts both due to what the MPC accepts is a significant and still developing conventional policy tightening but also where the unconventional policy moves are important too.
This is not just the marked drop in money supply growth rates but the factors causing this, ie slumping bank deposits and credit levels (Figure 2) – the BoE admits to weakness in the later but seems to be dismissing the fact that we are seeing unprecedented falls in both. This we suggest is being caused, or at least accentuated by the BoE balance sheet reduction and is not something the BoE has anticipated, it citing the fact that QT in the U.S. in 2017 did not result in falling bank deposits. Perhaps this issue may be discussed more fully when Governor Bailey and his MPC colleagues give testimony on May 18 on the issue of QT to the Treasury Select Committee
Figure 2: Sharp Fall in Deposits Triggering Sharp Fall in Credit?
We think that this all the more relevant at this juncture as a) any fall in deposits by households as is now occurring implies even less of a savings buttress and thus accentuates downside risks. But b) with deposits being a key aspect of any bank’s ability and willingness to lend, it is not surprising that the level of private sector credit has started to fall. This all the more so as swings in private sector credit correlate well with real GDP swings even though the former is a nominal aggregate (real private credit has slumped far more). However, the salient point is that even if the upside inflation risks which the MPC majority envisage do materialize, the latest MPR still points to inflation back to target (Figure 1).