MNI BOE WATCH: BOE Downshifts To 25BP Hike, Rates Restrictive

The Bank of England opted for a smaller 25-basis-point hike at its August meeting after June’s surprise 50bp, taking Bank Rate to what policymakers said was clearly restrictive territory at 5.25%.

While Governor Andrew Bailey was careful at the post-meeting press conference to avoid commentary as to where Bank Rate would peak, leaving the door open to another hike if inflation pressures proved persistent, aggressive tightening appears to be drawing to a close. The Monetary Policy Committee's inflation forecasts on the modal, or most likely, projection were raised from May but this was in part due to the assumption that upside risks previously reflected in a markedly higher mean forecast had crystallised and could now be included in the mode.

There is evidence that Bank rate is now above the so-called neutral rate of interest, known as r-star, putting downward pressure on inflation, said Deputy Governor Ben Broadbent, though he added that he sympathized with the view that this variable was hard to measure other than in hindsight.

AT TARGET

The MPC's projections showed inflation at 1.7% in two years and 1.5% in three years' time on the modal forecast and also a little below the Bank’s 2.0% target on the mean path. These projections were conditioned on Bank Rate averaging a little under 5.5% over the next three years, so varied little from the Bank’s forecasts based on unchanged policy, with the benchmark staying at 5.25%.

But Bailey pushed back against the reading that these projections meant no more hikes would be needed, saying instead that it "illustrates that different paths for Bank Rate can secure a return of inflation to target."

The projections were, however, compatible with the view that the peak in Bank Rate would not need to be much higher unless the economic outlook changes, although the MPC is placing less weight on its medium-term forecasts in light of its well-publicised difficulties in predicting what will happen to inflation in the current environment. (See MNI POLICY: BOE Hikes Whilst Seeking New Inflation Model)

Still, Bailey noted that key labour market data had been mixed, with signs of easing coming from a higher unemployment-to-vacancies ratio but with earnings rising faster than expected and services inflation proving stubbornly high. The Bank forecast that after hitting 7.2% on the year in June, services inflation would only edge lower through the three-year forecast.

SERVICES INFLATION

Services, closely linked to earnings growth, are now contributing more to inflation than energy prices or goods, Bailey noted, describing its evolution as "unwelcome news".

The nuanced messages from Bailey and colleagues, combined with a hike by 25bp rather than the 50bp some analysts had forecast as well as with the projections saw markets interpreting the decision as a little more dovish than expected, with sterling initially falling and the market-implied peak rate dipping to 5.65% before moving back towards 5.75%.

There had been speculation that the Bank would release details of its planned gilt sales programme in August, but the MPC said it would vote on a target for reducing its bond stocks at its September meeting. (See MNI POLICY: BOE To Speed Up QT, Detail Likely In Sept)