BoE Keeps Door Open for One More 25bp Hike

Bank of England hikes rates & keeps options open for further increases.

The BoE has hiked rates by another 25 basis points (Fig1) and kept the door open to more if inflation data come in higher than expected between now and the next meeting in June. Another hike is possible, but with inflation forecasted to be well below target in a couple of years' time, I think this tightening cycle is reaching its limit.

Fig 1: BoE hikes rates as expected.

Source: https://www.finlogix.com/calendar

As widely anticipated, the Bank of England has implemented a rate increase, bringing it to 4.5%, while maintaining flexibility for future meetings. The decision to raise rates was supported by seven committee members, mirroring the consensus reached in the previous two meetings. Although there will likely be considerable attention on the substantial growth upgrades following the meeting, these revisions were already hinted at in the BoE's previous meeting minutes. Furthermore, the upgrades can be attributed, at least in part, to the recent decline in natural gas prices. Of notable importance is the Bank's intentionally ambiguous forward guidance, suggesting the possibility of further rate hikes if inflation exhibits more persistent trends.

Looking beyond the surface, there are indications that the current tightening cycle is nearing its end. Policymakers frequently reference the inflation projections for a two-year timeframe, as this period is when interest rate adjustments exert the most significant influence. Examining the previous forecasts from February, the committee anticipates inflation to remain significantly below the target, around 1% by mid-2025. Importantly, this holds true regardless of whether interest rates align with the path anticipated by financial markets or remain unchanged at their current level of 4.5%.Admittedly, some of this will be accounted for by energy, and the committee has made a point of saying the risks are skewed to the upside. But the simple fact is that the Bank’s own forecast shows little need to take rates higher. As the chart below shows, it's unusual that the two-year-ahead forecast is so far below target.

Fig 2: The BoE is forecasting inflation well below target in two years' time.

Source: Based on the MPC's modal inflation forecast

What lies ahead? I maintain the belief that this will likely represent the peak of the current tightening cycle, although I acknowledge that this is highly dependent on forthcoming wage and inflation data. While a rate hike in June remains a possibility, it is not my central scenario now. The anticipated rate cuts by the Federal Reserve later this year do offer the Bank of England some flexibility.

The more intriguing question pertains to the timing of future rate cuts. In my opinion, it is unlikely to occur within this year, partly due to the resilient state of the job market. The Bank has moderated its projected increase in the unemployment rate and, in turn, revised its wage growth predictions. However, on the other hand, the inflation outlook is showing signs of improvement.

Indeed, inflation has surpassed the Bank of England's February projections, primarily driven by more persistent food and goods prices. However, when it comes to monetary policy, these factors are less influential compared to service sector inflation, which has been less volatile and seems to be approaching a peak. Surveys indicate that firms' pricing expectations are moderating, and assuming gas prices remain low, there are compelling reasons to anticipate a significant decline in service sector inflation over the next 12 months.

Considering that interest rates are currently in what can be reasonably deemed as restrictive territory, I believe the Bank will initiate a gradual adjustment towards a more neutral stance through rate cuts by this time next year. My estimation points to the first-rate cut taking place in May of the following year.

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