MNI STATE OF PLAY: BOE Hikes 50bps, Stresses Uncertain Outlook

The Bank of England’s Monetary Policy Committee said on Thursday it voted eight-one in favour of its first 50-basis-point rate hike since obtaining operational independence in 1997 and unveiled plans for steady quantitative tightening even as it stressed very high levels of uncertainty as the economy heads for five consecutive quarters of contraction.

With the BOE’s economic forecasts highlighting the dilemma facing the MPC, Gov. Andrew Bailey told a press conference that every option would be on the table for Bank Rate in September, and that 50 bps would not now be the new normal.

By increasing the pace of tightening, the MPC is aiming to stop higher inflation getting embedded in the system, by driving up wage demands and encouraging firms to raise prices, even as the economy heads for a protracted slowdown.

Assuming market rates, which see Bank Rate rising from 1.75% after the August meeting to a peak close to 3%, the BOE expects consumer price inflation to plummet to just 0.76% in three years' time, from an energy-driven high of 13.3% this October. Even on unchanged policy, inflation would slide to 1.27% three years ahead, easily undershooting the 2% target.

DIVERGENT FORECASTS

The BOE’s Monetary Policy Report central forecast, which assumes wholesale energy prices follow market curves before flatlining after six-months and that fiscal policy is unchanged, shows the UK entering a five-quarter recession starting in the fourth quarter of this year, with a 2.2% contraction in GDP from peak-to-trough. But the Committee is placing more weight than usual on an alternative, market curve-based scenario, which is pricing in additional fiscal stimulus from the next UK prime minister and a retracement in energy prices. This projection sees a smaller peak-to-trough contraction of 1.5%.

Bailey, Deputy Governor Ben Broadbent and Deputy Governor Dave Ramsden all highlighted the limitations of the central forecast at the press conference.

While the outlook for rates is unclear, the BOE is determined to push ahead with gilt sales. Markets would have to be “very stressed” for any change to the plans for GBP10 billion in active sales a quarter from September as part of a reduction in gilt holdings of GBP80 billion in the first year, including roll-offs, according to Ramsden. (See MNI INSIGHT: BOE's QT Pace Known, Terminal Point Unknowable)

QT will take place “in the background” to changes in Bank Rate, which is the Bank’s primary policy tool, he said. The BOE gave no indication of how far it expected to go in shrinking its GBP844 billion stock of gilts, but said it would reassess the pace of sales after 12 months.

The Bank is keen to ensure that market participants have ample central bank reserves, and to avoid a rate 'snap-back' where short-term market rates become detached from the policy rate.

A new Short=Term Repo (STR) facility will keep market rates close to Bank Rate so that the MPC can carry out QT "independently of the implications of the supply of reserves,” the Bank said.