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MNI (London)
By David Robinson
     LONDON (MNI) - The Bank of England Monetary Policy Committee's (MPC's)
widely anticipated May rate hike is now shrouded in doubt, with uncertainty over
sterling and the extent and magnitude of the pass-through from its
Brexit-related depreciation to consumer price inflation thickening the fog, MNI
     In a BBC interview that ran Thursday, Bank Governor Mark Carney indicated
that MPC members could well split over a May hike. The two MPC members who voted
for a hike in March, Ian McCafferty and Michael Saunders, are unlikely to back
down -- underlined in a speech by Saunders earlier Friday.
     "I am sure there will be some differences of view but it is a view we will
take in early May, conscious that there are other meetings over the course of
this year," Carney said.
     Sterling Overnight Rates (SONIA), which at one time had been pricing in an
over 90% of a May hike, are now attaching around a 55% chance.
     Carney's comments sent sterling lower and sterling's volatility could
impact the BOE's inflation models ahead of the May Inflation Report.
     The Bank's research has highlighted the irregularity of the speed and
magnitude of the pass-through from currency moves to headline inflation. The MPC
had assumed a prolonged upward effect on consumer prices from the Brexit
depreciation but it overestimated, as inflation and imported inflation pressure
may be fading faster than expected.
     Former BOE MPC member Kristin Forbes led Bank research into exchange rate
pass-though which highlighted the irregular effects of currency moves on
headline inflation. She set out how the nature of the shocks which move the
exchange rate were key to the relationship to prices, with supply, demand and
policy shocks having varying effects.
     The Bank took on board Forbes's work and MPC members' best collective view
was sterling's Brexit related depreciation would impact prices over four years. 
     The February MPC minutes acknowledged that members were aware that they may
have got it wrong, noting a possibility that the contribution of imported
inflation pressures would diminish more rapidly than in the central projection.
     First quarter inflation outturns suggested that this may have happened.
Headline CPI came in at 2.5% on the year in March compared to the Bank estimate
of 2.8% and over the first quarter averaged 2.7% compared to the February
Inflation Report projection of 2.9%.
     If inflation does return fairly swiftly to around the 2.0% target, that at
the very least makes communicating the case for a May hike trickier.
     While the MPC wrestles the likely pass-through from sterling, it also has a
problem in factoring in the currency's move into its inflation predictions. 
     The MPC has an idiosyncratic approach to projecting where sterling is
heading, resulting from an esoteric split among its members in 1999.
     Then member Sushil Wadhwani asserted that the Bank's approach of relying
uncovered interest parity (UIP), whereby exchange rates are assumed to move in
line with interest rate differentials, performed worse than random walk (RW).
     A person familiar with the debate at that time told MNI that the MPC was
evenly divided on the issue and then Governor Eddie George refused to rule one
way or the other and the MPC decided to take an average between the current
sterling level, as implied by RW, and the path implied by UIP - a convention it
still follows. 
     In the February Inflation Report, it projected that sterling on its
Effective Exchange Rate Index (ERI) would virtually flat-line. The inflation
forecasts were conditioned on sterling edging up from its Q4 2017 outturn of 78
to 79 in Q4 2018 and staying there through to Q4 2019.
     The sterling ERI was running markedly stronger than this, at 80.6723 on
Wednesday, but it was knocked hard Thursday by Carney's BBC interview.
--MNI London Bureau; tel: +44 203-586-2223; email:
--MNI London Bureau; tel: +44 203-586-2225; email:
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MNI London Bureau | +44 203-865-3812 |