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SP500 PE Ratio vs. CPI Inflation

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The Bank of England now sees inflation overshooting its 2.0% target near-term before peaking at around 2.5% in the fourth quarter of this year, but it is likely to keep policy on hold despite a vote at its May meeting by its chief economist to reduce asset purchases.

Eight of the nine monetary policy committee members voted for leaving Bank Rate at 0.1% and the gilt purchase total at GBP875 billion, though Chief Economist Andy Haldane broke ranks and voting to reduce the target to GBP825 billion. Haldane, however, is set to leave after the June meeting, diminishing the significance of his vote.

Asked about the anticipated inflation spike, from the most recent 0.7%, Governor Andrew Bailey and Deputy Governor Ben Broadbent said they expected it to be transitory, as it reflected a mix of increased energy prices and fiscal support.

"We don't see that there is any good line of argument which says that those base effects are going to translate into embedded inflation," Bailey told the post-meeting press conference, but he added that they would watch very closely for signs of higher inflation becoming embedded.

Broadbent said that the overall profile of the UK budget deficit, with a cut in fiscal giveaways ahead after Covid income support schemes and large investment tax credits, would result in "more negative effects later on in the forecasts."

The Bank also slowed asset purchases to a weekly pace of around GBP3.4 billion from GBP4.4 billion, allowing it to keep purchases going until the end of the year. Bailey said that this should not be confused with the tapering of other central banks, as the target stock of purchases was fixed and unchanged.

According to the May Monetary Policy Report, inflation should fall back to around target in the second and third years of the forecast period, either if Bank rate is kept flat the current 0.1% or if it is hiked to 0.4% by 2023, in line with market expectations.

COVID SAVINGS

The BOE's near-term growth forecast was pushed up sharply, to 7.25% this year from 5% but the 2022 forecast was cut to 5.75% from 7.25% and in 2023 growth was forecast to be just 1.25%, a return to, at best, the sluggish pre-crisis trend.

The MPC's upgraded its estimate of the proportion of involuntary savings due to Covid that would be spent, to 10% from 5%.

Broadbent, however, downplayed the significance of the change.

This additional spending has "some effect on the level of consumer spending further out … with excess saving somewhere between 10 and 20% of annual consumption, if you shift your share of what is spent out of that from 5 to 10% you are making a difference to the level of consumption of between half and one percent," he said.

Any case for tightening would be based on only minor differences in analytical emphasis, said Bailey, referring to market expectations of a couple of rate hikes over the next three years.

"The difference is pretty small. To my mind it is well within any sort of margin of error. I think that tells us that these are pretty-fine judgements," Bailey said.