MNI STATE OF PLAY: After Hike, BOE Flags At Least Two More

-No Guidance On Timing Of Next Hike; Postpones Commentary On QE Unwind

By David Robinson

     LONDON (MNI) - The Bank of England Monetary Policy Committee duly delivered

its 25 basis point hike in November and made clear further tightening was very

likely to be needed but it offered no guidance on the timing of the next

increase and it steered clear of discussing quantitative easing unwinding.

     The absence of any guidance over another near-term hike and the MPC's

ditching of its line that markets may be under-estimating overall tightening put

the package at the dovish end of market expectations. The committee's approach,

however, is very much about sequencing -- get the first hike out of the way and

assess reactions to it before addressing the timing of the next hike, or hikes,

before tackling QE unwind. 

     In the November Inflation Report, the Bank published detailed work on the

sensitivity of businesses and households to an interest rate change. The

conclusion was that both were largely well-placed to withstand a hike and

November's 25bps increase will allow the Bank to check if things play out as it

has predicted.

     The recent public comments by BOE Governor Mark Carney and his deputy Ben

Broadbent have sent the message to business and consumers that the November

increase is unlikely to be a one-off but they did not shake-up market pricing,

which was already factoring-in a couple more hikes.

     Carney's message, however, was not all that dovish as he made clear that

two hikes were likely to be required as a minimum. 

     "Our forecast is conditioned on a market curve which has two additional

rate increases over the forecast horizon, and we ... need those two additional

rate increases in order to get that return of inflation to target," Carney said

at the Inflation Report press conference. 

     "In fact, if you look closely at the forecast, inflation approaches the

target, (but) it doesn't quite get there and the economy is likely to be in a

position of excess demand, in other words, running a little hot at that point,"

he added.

     On market rate expectations for a couple of hikes, the headline inflation

measure, CPI, was projected to be at 2.15% in three years' time, still over the

2.0% target, albeit modestly. 

     The MPC's constant rate forecast, with Bank Rate held at its post November

hike 0.5% level, showed CPI only drifting down from 2.98% in the fourth quarter

of this year to 2.39% in three years' time.

     The MPC had allowed CPI to run above target in a trade-off to support

employment and growth, but as Carney pointed out "our normal horizon to return

inflation to target is 18 to 24 months."

     The long, and variable, policy lags suggest further tightening should not

be that long delayed if the committee is serious about getting CPI sustainably

back to 2.0% rather than leaving it lingering above it.

     "Once that trade-off goes away ... and it's almost gone, the justification

for an inflation targeting central bank to continue to overshoot, to continue to

miss its target, three years out, disappears," Carney said.

     -BREXIT REMAINS A WILD CARD

     The key to the MPC majority's approach is that its members believes that

there is little spare capacity left in the UK economy and that supply growth is

likely to remain sluggish, so continued GDP growth rates of just 0.4% to 0.5%

quarter-on-quarter, or around 1.5% a year, are likely be enough to fuel

inflationary pressures. 

     The two dissenters who backed no rate increase, deputy governors Jon

Cunliffe and David Ramsden, are unconvinced earnings growth will accelerate,

making them doubtful about the emergence of sustained inflationary pressure.

     One factor depressing UK supply growth in the MPC's judgement has been the

uncertainty around Brexit. Despite world economic growth rebounding, business

investment growth in the UK has been subdued, suggesting local factors are

weighing.

     "Since the referendum, what we have seen is that business investment has

picked up, but it hasn't picked up to the extent one would have expected given

how strong the world is, how easy financial conditions are, how high

profitability is and how little capacity they have ... It should really be

booming, and it's just growing," Carney told ITV's Peston programme on Sunday.

     As perceptions of the likelihood of a Brexit transition deal and the shape

of the final deal with the EU evolve, businesses could go ahead with previously

deferred investment or cancel it altogether.

     "A little more progress, or a little less progress, will matter for the

economy to the extent to which people change their attitudes, and change their

spending plans, both positively and negative, on supply and on demand," Carney

said.

     Resolution of some of the big questions around Brexit could have a sizeable

effect on the economic outlook but while the impact may be the large the

question of whether clarifying the Brexit outlook will push up or down on supply

and demand growth remains open.

     "I would caution ... that the consequences of resolution on Brexit are not

... automatic for the path of inflation. It doesn't necessarily go in one

direction," Carney said.

     The MPC is basing its forecasts on a smooth Brexit transition, with the end

state a somewhat less open UK economy than before the referendum vote. Those are

stylised assumptions and a disorderly Brexit with, say, the UK ending up with no

deal and unprepared to handle the new trading regime, lies outside the forecast.

     Not only is the directional impact of Brexit on inflation uncertain, it

could still end up being something not even factored into the current forecast

range.

     -QE UNWIND: WE DON'T WANT TO TALK ABOUT IT

     With the MPC hiking Bank Rate for the first time in a decade, the question

of how unwinding quantitative easing will fit into the tightening process was

bound to come into focus.

     The MPC's current guidance, set out in the November 2015 Inflation Report,

is that QE unwind, whether through non-investment of the proceeds of maturing

gilts or active sales, will only begin when Bank Rate is raised to a level from

which it can be materially cut. 

     The MPC reckoned back then that level was around 2%, some 75 basis points

above the level sterling overnight rates suggest Bank Rate will reach five years

ahead.

     The MPC could stick to its approach of initially using Bank Rate as the

active tightening but at least get QE unwind on the map by lowering that 2%

trigger level. 

     Carney, in recent evidence to the Treasury Select Committee, sketched out a

case for dropping it to around 1.5% -- on the grounds that average UK tightening

cycles have been about 150 basis points.

     At the Inflation Report press conference, however, he was keen to avoid

muddying the waters by saying anything of note on QE unwind at all.

     Asked if there had been any discussion about reinvesting gilt proceeds and

the 2% threshold, with the Fed starting quantitative tightening at 1.25%, Carney

stone-walled, while avoiding referring to the 2% level.

     "Well I, for the purposes of today, I just leave ... the guidance that the

MPC gave a few years ago," Carney said.

     He said that the MPC would like to go through a conventional rate cycle,

which would result in "Bank Rate being notably higher than where it is today,"

without specifying what that level would be.

     "We've just taken a decision today. I don't want to inadvertently send a

signal about something that would be much further down the track," he added.

     Nevertheless, while actual QE unwind could end up being much further down

the line the MPC could at any stage chose to update its guidance on it.

     For now, sequencing is paramount for the committee. The first hike is done,

the reaction of economic actors will be analysed and the probable timing of the

next hike is likely, to use Carney's old phraseology, to come into sharper focus

around the turn of the year -- in the run up to the February Inflation Report.

--MNI London Bureau; tel: +44 203-586-2223; email: david.robinson@marketnews.com

--MNI London Bureau; tel: +44 203-586-2225; email: les.commons@marketnews.com

[TOPICS: M$B$$$,M$E$$$,MX$$$$,M$$BE$]