BoE Preview (Jun 18): Splits to Widen, But Stable Policy Outlook Intact
Not only this month, but we see the BoE being on hold for the rest of the year with rate cuts then resuming through 2027. Although markets are pricing just over two hikes from the current 3.75% with a 50%-plus probability of the first being delivered at the July 30 MPC meeting, our view is hardly eccentric, largely chiming with the UK economist fraternity and even the more recent OECD prognosis. The view is based around ever-clearer signs of a weaker labor market (that might also imply a better productivity backdrop) alongside a softer housing market, all hampered by what are tight(er) financial conditions (Figure 1). This does not mean that MPC splits will not widen (we think they may rise from one to three this month), and there are clear risks that the BoE may take out some ‘insurance’. But, more likely, we think Governor Bailey’s hand remains on the tiller and he is explicit in suggesting that ‘the context of softness in the real economy and uncertainty around the scale and duration of the shock, tolerating temporarily above target inflation to provide some support for the real economy is appropriate’.
Figure 1: Official Rate Level Far From the Whole Story
Source: BoE, Bloomberg, CE
Very clearly, the BoE kept rates on hold at the end of April and with the only dissent from Chief Economist Pill wanting an immediate hike. But splits were more evident in the individual MPC member statements (as expected) where more diverging views in an around the three scenarios that the BoE is now projections all based on modest hiking of around 50 bp over the coming year. We still think that the BoE is offering too much information in these individual views and as a result is continuing to confuse markets. But among the key and relatively common themes is that financial conditions have tightened even without actual hikes and that the labor market is loosening, issues with which we fully concur.
What is notable and as the updated projections do show, is that this energy shock is justifiably viewed by the BoE as being different to that of 2022, occurring at a point when the economy is operating with a margin of spare capacity and where policy is already restrictive. We think this very much reduces the chances of second round effects as does the already loosening labor and housing markets.
Given ever tighter financial conditions, we still see at least two and probably three more 25 bp rate cuts ahead but now deferred to starting no sooner than Q4 and then extending into 2027. Admittedly, rate hikes still seem to be the more likely policy more implicit in BoE thinking, with some suggestion that without them then the tightening in financial conditions seen of late would not be validated. We think this is misplaced, not least as some of the tightening in conditions affects the likes of political and fiscal risks. As for the three scenarios (A seeing energy prices follow market thinking while C sees not only higher energy costs but more persistently too) we are puzzled that the combination of the energy shock and more restrictive policy not only fails to deliver any kind of recession even in the most severe scenario but that all three outcomes see little variation in the growth outlook – ie just 0.1 ppt per year between each outlook
It is notable that Governor Bailey has recently referenced the approach of the BoE in 2011, which kept rates on hold even as UK energy inflation soared to 20%, citing its mandate to tolerate deviations from target in a bid to avoid unnecessary harm to the economy and jobs. A BoE survey of senior executives released of late offered tentative support for Bailey’s implicit wait-and-see approach (or what he prefers is an ‘active hold’), with evidence that companies will resist inflation-fuelling pressure from workers for higher wages in response to the current crisis. The expected price growth reading in the regular BoE-compiled Decision Makers Survey is among the weakest since 2022 and we would also point to pay growth already broadly consistent with the BoE’s inflation target. The survey also showed expectations for employment growth remaining in clear negative territory. All of which adds to a picture of a UK economic backdrop vastly and increasingly different to four years ago.