International | Aug 03 2017
By Kathleen Brooks, Research Director, City Index
Bank of England Preview: Will there be a rate hike in 2017?
The Bank of England will announce its latest policy decision on Thursday at 1200 BST, at the same time the penultimate Inflation Report of the year will also be released and then at 1230 BST Governor Mark Carney will give a press conference.
We do not expect the BOE to hike rates at this meeting, although there are some respected investment banks looking for a surprise hike. We believe a few things could keep them on hold for another month: firstly, the bank is likely to announce an end to its Term Funding Scheme when it expires in early 2018, which could be enough tightening for one meeting. Secondly, without a transition deal in place for Brexit, the UK is still on a cliff edge when it comes to [Britain] leaving the European Union, thus it could be argued that the UK still needs the comfort of lose monetary policy imposed by the BOE after last year’s vote.
There is a slight increase in market expectations for one 25 basis point rate hike to 0.5% by the end of this year, with a 37% chance of a rate hike, which is up from 32% a week ago. We believe that there are three potential market-moving events from this meeting, which, if they occur, could cause a rapid re-pricing of expectations for a UK rate increase, and would have knock-on effects for other UK asset prices. They are:
1. The MPC vote split: at the last meeting Ian McCafferty, Michael Saunders and Kirsten Forbes all voted to hike rates. With Forbes having left the bank since the last meeting the question is will her replacement, Silvana Tenreyo, follow in her footsteps? Her time at the Mauritius central bank suggests that she has dovish leanings, she has also voiced concern about the economic impact of the Brexit vote, thus we doubt that she will follow in her predecessor’s footsteps. Instead, Andy Haldane, the chief economist at the BOE, is the one to watch. He has traditionally been dovish, but he teased the hawks by talking about the prospect of an early rate rise last month. If he does join McCafferty and Saunders then we would expect a reaction in the pound, and a potential re-pricing in the rates market, with the prospect of an earlier rate hike sending bond yields higher. However, if Haldane doesn’t follow through and instead votes to keep rates on hold, this would see the number of dissenters fall to 2, which could be considered a dovish outcome. At this stage we view the chances of another 5-3 split at roughly 50%.
2. Inflation: prices matter, but with inflation coming off the boil in June, the focus will be on how content the BOE is with inflation moderating but remaining above the target rate. In an interview with Sky News on July 18th, the Governor Mark Carney sounded fairly calm about price pressures. This makes any comments about wages the key inflation comment to look out for. Weak wage growth has been a problem in the UK and elsewhere for many years, and it is a complex problem to solve that involves productivity, inflation and corporate trends. With inflation pressures easing as sterling recoups some of last year’s losses, combined with no change in the outlook for wage growth, we expect the BOE to revise down its inflation forecast, which could reduce the expectations of a near term rate hike and dampen sterling.
3. Carney press conference: BOE Governor Mark Carney has a way with words, on June 28th he sent the pound surging after joining a chorus of hawkish central bank speak saying that there is a limit to the BOE’s tolerance of above-target inflation. Thus, even though he has been cautious since then, the Governor could set the tone for this meeting and if he tries to convince the market that a rate rise could happen by year-end then we could see a rapid re-pricing of UK rate expectations, and thus the pound, in the near term.
Market outcome:
We believe that the bigger market reaction would be a “hawkish” outcome from this meeting, with a 3-5 vote split in favour of remaining on hold, but with a firm warning from the Governor that a rate hike is coming by year end. This outcome could send GBP/USD back to 1.3450, the high from 6th September, cable’s bullish trend is strong and it isn’t looking overbought quite yet, which could also support a move higher in this pair on the back of a hawkish outcome on Thursday. The trade weighted pound is also looking perkier, and we may see a broad rise in sterling if a late 2017 rate rise is touted by the Governor as a possibility. The historical relationship between the pound and the FTSE 100 suggests that if the pound rises then the FTSE 100 could struggle, which has been the case very recently as the pound has surged vs. the USD, while the FTSE 100 has struggled.
However, if there are only two dissenters on Thursday and the Governor does not hint at an early rate rise, will the pound go the way of the euro and continue its uptrend while disregarding central bank speak? We tend to think so, especially versus the dollar, so any pull-back to the 1.30 level in GBP/USD could be used as a buying opportunity.
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