MNI BOE WATCH: BOE To Hike As Rate Expectations Surge

The Bank of England is widely expected to deliver another 25-basis-point hike at its June meeting, lifting Bank Rate to 4.75%, and the Monetary Policy Committee will face a tricky task to avoid further priming rate expectations which have surged on strong data.

With the MPC admitting the failings of its own projections and adopting a “data-dependent” policy approach, rate curves have moved substantially higher as economic indicators point to inflation remaining elevated. Markets are now pricing in a peak in Bank Rate just below 6%, and the curve is over 100 basis points higher through Q1 2024 than at the time the Bank prepared its May Monetary Policy Report.

One approach might be for the Committee to modify its policy statement, which In May stated that it "would continue to monitor closely indications of persistent inflationary pressures ... (and) if there were to be evidence of more persistent pressures, then further tightening in monetary policy would be required." It had previously dropped a line saying it would act "forcefully" if required.

The MPC's dilemma stems from its concern over its baseline inflation models, which it says were formulated in times of low inflation and underestimate price rises by a hard-to-quantify amount, making it difficult for it to use its projections to steer rate expectations lower. In May, its modal, or most likely, projection showed inflation substantially undershooting target by the end of the forecast period, but instead it chose to highlight its mean inflation forecast, which showed inflation falling to target. (See MNI POLICY: BOE Hikes Whilst Seeking New Inflation Model)

MORTGAGE WORRIES

Meanwhile, market speculation of a peak in rates near 6% is feeding headlines about surging mortgage costs and declining loan availability. A report by the Resolution Foundation think-tank stated that annual mortgage repayments were on track to be GBP15.8 billion higher by 2026, up from its estimate of GBP12 billion in May. With many mortgage holders on fixed-rate deals and yet to readjust since late 2021, the BOE estimates only a third of policy tightening has fed through to consumers.

Previously Deputy Governors Ben Broadbent and Dave Ramsden have pushed back against elevated rate expectations by releasing internal optimal policy projections (OPPs), which showed that the markets’ expectations for tightening would result in a hefty hit to GDP and substantial inflation undershoot.

Broadbent in October stated that based on the OPP at the time, hiking Bank Rate to the then-expected peak of 5.25% would probably subtract almost 5% from GDP over the hiking cycle. But, given the Bank’s forecasting challenges, there is a question as to how seriously markets would receive any updated OPP.

The BOE’s Court, its governing body, announced last week that it was launching a formal inquiry into the forecasting process.