MNI POLICY: BOE Points To 4% Peak At Most, Then Rate Cuts

The Bank of England is heading for a cycle peak in Bank Rate of no more than around 4%, followed by a fairly rapid switch to easing to avoid a slide in projected inflation below target, projections from its November Monetary Policy report and comments by policymakers suggest.

The BOE’s “best view” of the peak is closer to the current 3% level of Bank Rate than the 5.25%, based on previous market assumptions of the highest point of the cycle, which the BOE used in its market-based projections, Governor Andrew Bailey told a news conference after its Nov 4 decision. While the Bank and its chief economist Huw Pill have signalled more rate rises are to come, this implies a peak of no more than roughly 4.1% at most, still well below the 4.7% priced in by investors today.

The BOE’s Monetary Policy Report projections imply that inflation will substantially undershooting the 2% target within the forecast horizon if rates either follow the market path or remain at a constant 3%, suggesting that cuts may have to follow the hiking without much delay.

On market rates, the MPR shows the target CPI measure at 1.43% in two years' time, according to the modal or most likely projection, and at just 0.02% in three years. Assuming Bank Rate stays at 3%, it falls to 2.16% in two years and 0.84% in three.

ACTIVIST APPROACH

An activist approach, of hiking rapidly then reversing, may be an optimal policy response to such an outlook, according to at least one Monetary Policy Committee member. In a speech at an MNI event on June 20, Mann argued that if near-term inflation is the dominant concern, then it is addressed by swift hikes, while if medium-term output losses are a problem, then policy needs to reverse promptly. Mann said. (MNI BRIEF: BOE Mann Sees Inflation Pressure From Weak Sterling)

With the November MPR forecasting eight consecutive quarters of negative growth at market rates, and inflation still above 10% in the first quarter of 2023, arguments for a trade off will build.

Some MPC members, though, may draw different conclusions. The mean, rather than the modal, projection showed CPI falling below the 2.0% target on constant rates only in Q3 2025, potentially weakening the extent of any rate reversals that may be required . And on the other side of the hawk-dove spectrum, the minutes showed that Silvana Tenreyro appeared to be unpersuaded that much further tightening, if any, would be needed.