BoE: Hawkish, but still unlikely to hike this year - ING

The Bank of England voted 6-2 in favour of keep rates on hold today, but continued to signal that rates could rise faster than markets think, explains James Smith, Economist at ING.

Key Quotes

“Here’s our key takeaways:

Investment still expected to drive the economy forward as consumer spending lags

The Bank of England has said that it expects low interest rates and high profitability to lift investment over the next few years, even as firm’s compete with Brexit uncertainties. But there’s a big ‘if’: that the transition to Brexit is smooth.

That’s obviously quite a big assumption, and until details on a potential transition deal are firmed up, we suspect firms will continue to take a cautious approach to investment.

BoE still very optimistic on wage growth, despite lower 2018 forecast

Most people, including the BoE, accept that virtually all of the recent inflationary pressures stem from the pound's post-Brexit fall. The bigger question is what happens to domestic inflationary pressures in the medium term.

Here, the Bank has cut its 2018 wage growth forecast from 3.5% to 3%, but that still implies a significant recovery from the sub-2% readings we've seen in recent months. By the MPC’s reasoning, the UK has reached full employment and that should start to drive up pay over the forecast period. The Bank has also in the past pointed to temporary factors, such as pension changes and the apprenticeship levy, as keeping a lid on wage growth so far this year.

However, with political uncertainty likely to persist for some time, flagging consumer demand and rising import costs, we think it’s unlikely that we’ll see a drastic acceleration of pay increases any time soon. We suspect wage growth will stay at or below 2% for much of this year

There’s still a wide ranging of views amongst the MPC the growth-inflation trade-off.

When you dive into the minutes of today’s meeting, it’s clear that the MPC still aren’t united around the baseline views outlined above. The hawks continue to have “limited tolerance” to inflation rises, whilst the more dovish members think that the effect of uncertainty on investment could be “larger than assumed”.

But unless we do start to see clear signs of domestic inflationary pressures emerging, we think the MPC as a whole will continue to look through the latest price spikes and focus more heavily on the weaker growth outlook.

We still don’t expect a rate hike this year, despite BoE signals

Perhaps the most interesting part of today’s statement  is the fact that the Bank still think investors are too cautious on the outlook for interest rates. That’s despite the UK swap curve steeping noticeably since Haldane & Carney’s hawkish comments in June.

However, with wage growth likely to stay below 2% for much of this year, and businesses likely to remain cautious on investment, we still think the Bank of England is unlikely to actually follow through with their hawkish signals and hike rates this year.

But what if they do hike?

Well, we think it is much more likely that we enter a "one (or two) and done" scenario rather than the start of a more prolonged hiking cycle. For one thing, the MPC will want to tread very carefully given the rapid accumulation of household debt we’ve seen over the past few years.

The challenge for the Bank will be to effectively communicate this rate outlook to the markets, and they would most likely characterise a hike as simply removing the emergency stimulus put in last year. Whether markets interpret it this way is different question.”