MNI STATE OF PLAY: BOE Hikes, Sees Larger Inflation Undershoot

The Bank of England said it was raising its policy rate by 25 basis points to 0.75% on Thursday but softened the move with gentler policy guidance and a warning that inflation down the track could undershoot by even more than it had previously expected.

Not one Monetary Policy Committee member made the case for hiking by more than 25 bps in March, while Deputy Governor Jon Cunliffe voted for unchanged policy, placing heavy weight on the hit to real household incomes from the conflict in Ukraine. Having previously said that further modest tightening in coming months was "likely", the MPC softened this guidance to say only that it "might be appropriate."

In its first collective assessment of the likely impact of the war, the MPC said inflation is set to hit around 8% in the second quarter and possibly rise higher later this year, but the conflict will have a depressing effect on economic activity and contribute to inflation dropping more than previously expected below target down the line.

OVERBLOWN PRICING

As the MPC sets policy on the basis that rate changes take 18-24 months to feed through, increases later this year would only take full effect when inflation is already back around or below target, suggesting that market pricing showing a rapid string of hikes may be overblown.

Before the release of the March minutes, market pricing showed Bank Rate rising to between 2.00 and 2.25% by the end of 2022, and implying a 20% probability of a 50-bps hike in March, according to MNI calculations.

The rise in energy futures prices due to the war in Ukraine "could temporarily push CPI inflation around the end of this year above the level projected for April (7.25%), which was previously expected to be the peak. Further out, inflation is expected to fall back materially, as energy prices stop rising and as the squeeze on real incomes and demand puts significant downward pressure on domestically generated inflation," the minutes said.

As the UK is a net importer of energy and goods, elevated prices in both sectors "will necessarily weigh further on UK real aggregate income and spending. This is something monetary policy is unable to prevent," the minutes stated, adding that policymakers had to aim to hit the target in the medium-term.

In its February forecasts, based on then-market expectations for the policy rate to peak at 1.4%, the MPC projected that inflation would hit 7% in Q2 before dropping below the 2.0% target to just 1.6% three years ahead. Updating this forecast to reflect pricing showing the policy rate hitting 2.0% would lead to CPI inflation of around 1.4% three years ahead, BOE Deputy Governor Dave Ramsden said in a speech last month.