MNI STATE OF PLAY: BOE Eyes Markets As It Ponders Gilt Sales

The Bank of England is widely expected to hike by 25 basis points for a fourth meeting in a row this week, lifting the policy rate to 1.0%, but while this is the level at which it has previously said it will consider beginning active sales of gilts acquired during its quantitative easing programme, it could opt for caution.

Even though some policymakers have argued that gilt sales at a time of abundant liquidity should have negligible effects on yields, others are less certain, and BOE Governor Andrew Bailey, generally strongly in favour of balance-sheet reduction, said last month that the BOE would not sell bonds in fragile markets.

Delay however could pose a communications challenge for the Monetary Policy Committee, which will have to address the question in its statement.

Some analysts suggest that the MPC could say it will wait until August before deciding whether to go ahead with sales. But it is far from clear that uncertainties caused by the war in Ukraine, China’s zero Covid policy and the twin threats of high inflation and recession will be significantly reduced by then.

Alternatively, if the MPC were to simply link sales to market conditions, the lack of any published guidance on the BOE’s parameters for judging them to be stressed or illiquid could leave the timing cloudy, as former MPC member Kristin Forbes has pointed out.

The Bank could opt to unveil a formal consultation process over gilt sales, although it already has a steady stream of market intelligence to inform its decisions.

Other factors may also influence the BOE’s thinking. MPC members might want to ensure that gilt sales do not impede their ability to hike sufficiently in this cycle to have enough conventional policy space to offset a future downturn through Bank Rate cuts rather than by having to resort to quantitative easing. UK easing cycles in recent times have averaged 150 basis points.

GUIDANCE

The OIS curve implies that a 25 basis-point increase is fully priced in for the May meeting with around a 20% chance of 50-bps and then around five further hikes this year. With market pricing so aggressive, there is scope for the MPC to go for 25 bps and to still deliver a dovish surprise, as occurred in March.

The full quarterly forecast round, to be published in the May Monetary Policy Report, may once again show inflation undershooting the 2.0% target at the two- and three-year forecast horizons, suggesting market rate expectations are overblown. While the near-term inflation peak looks certain to be raised again, perhaps to around 9.0%, inflation is likely to be shown fading subsequently as a hefty hit to real incomes kicks in.

Deputy Governor Jon Cunliffe, who opposed the March hike, could find an ally this time round. But, on the other side of the scale, MPC member Catherine Mann has said she might vote for a 50-bps hike, on the grounds that faster action could diminish the chances of inflation ratcheting higher.

The committee will also need to decide whether to stick with its deliberately more dovish guidance from March, which is at odds with market pricing. The guidance pointed to both upside and downside risks and said that further modest tightening in coming months may only be “appropriate”, rather than “likely”.