A huge government fiscal package will complicate decision making as the BOE ponders its next hike.
The Bank of England’s Monetary Policy is set to split at its September policy meeting over whether to hike by 50 or 75 basis points, with a potentially huge rise in government spending adding another layer of complexity to considerations.
Analysts mainly expect 50 bps although market pricing suggests a greater than 50% chance of 75. The only MPC member to give any steer towards a 75bps increase has been Catherine Mann, with a Sept 5 speech making the case for front-loading hikes to tackle the risk of medium-term inflation expectations ratcheting higher, with the others largely silent since the August meeting.
In evidence to the Treasury Select Committee on Sept 7, Mann's colleague Silvana Tenreyro argued that gradual tightening would reduce the risk of driving inflation below target in the medium-term, though she was also concerned about inflation expectations.
The MPC has previously demonstrated that it is prepared to leave markets hanging on the precise size of a rate change and there has been no move from the governor or his deputies to fine-tune expectations. The dominant view, championed by Deputy Governor Ben Broadbent, has been that the benefits of waiting until the meeting to assess data and events outweigh those of trying to steer market expectations.
The timing of a major government fiscal announcement capping household energy bills for two years and cutting taxes on Friday, the day after the BOE’s policy announcement, hampers the MPC’s ability to take the government measures into account, as it could not record any discussion of the package's details in the minutes of the meeting even if, as is usual, they are briefed on it.
While analysts suggest that the package could amount to 8% or more of GDP, depending on how wholesale energy prices evolve, the MPC may have to wait until its November meeting to take into account its undoubtedly significant implications for monetary policy.
BOE Chief Economist Huw Pill told the TSC that the energy price cap’s impact on inflation depends on details not yet available, though he added that while it should lower near-term inflation the more important question for policy was its impact at the "policy relevant horizon" at least 18 months down the track. While Pill was wary of elaborating, hefty fiscal support funded by borrowing looks more likely to push up, rather than down, on medium-term inflation and rates.
The MPC is also set to vote on whether to embark on active gilt sales, but it has made clear that the decision will depend on market conditions, and a jump in government borrowing could argue for postponement. (See MNI INTERVIEW: BOE Balance Sheet To Remain A Political Target)
Governor Andrew Bailey has, however, repeatedly made the case for reducing asset holdings to free up central bank fire power to deal with the next shock and has championed the idea of having gilt sales ticking away in the background with Bank Rate as the active policy instrument.
The MPC agreed at its August meeting that "there would be a high bar for amending the plannedn reduction in the stock of purchased gilts outside a scheduled annual review" and set out an active sales programme of around GBP10 billion per quarter. This gave it a sizeable amount of headroom against the mid-point of GBP60 billion in its August market participants survey of the amount of gilts it could sell over the next 12 months with disrupting the market.