MNI STATE OF PLAY: Gradualists Gain Upper Hand At BOE

Gradualists on the Bank of England’s Monetary Policy Committee look set to gain the upper hand over more activist members at this week’s meeting, which could see falling support for more aggressive near-term tightening.

After February’s five-to-four result in favour of a 25-basis-point rather than 50-basis-point hike, support for a 50-bp rise is not only likely to diminish but the vote could split three ways, with some seeing the case for delaying an increase at least until the May forecast round.

War in Ukraine, set to drive near-term inflation higher still through energy and food prices, will intensify the MPC's policy trade-off, with a sharp deterioration in real household incomes likely to eventually feed through to more rapid economic deceleration, higher unemployment and ultimately lower inflation. The UK is heading for recession by the end of this year, according to the National Institute of Economic and Social Research, using a similar macro model to that of the MPC’s projections.

MARKET EXPECTATIONS OVERBLOWN

Deputy Governor Dave Ramsden, who voted for 50 basis points in February, used his most recent speech on Feb. 22 to stress that market rate expectations for Bank Rate to rise to 2.0% from its current 0.5% were probably overblown.

If Bank Rate followed that market path "inflation would fall below our 2% target within two years and end the forecast at just 1.4%.” While rate expectations have since swung back towards 1.75% they would still point to significant undershooting of the target ahead if other conditioning assumptions are left unchanged by the Bank.

Ramsden could swing to the gradualists.

Among these, Chief Economist Huw Pill has argued that the Bank should re-establish a reputation for measured and purposeful steps in policy to dispel market narratives of a tendency to flip between excessive easing and excessive tightening. Another MPC member, Silvana Tenreyro, has raised doubts over the likelihood of sharp pay increases for workers and noted that Bank Rate, only at 0.75% before the Covid pandemic, may not have far to rise, notwithstanding sizeable risks both to upside and downside.

Analysts’ expectations are divided ahead of Thursday’s policy announcement, with another 25-basis-point hike seen as most likely. The MPC's February guidance that further tightening would likely be needed in “coming months” would be compatible with both a March hike or delaying until May, though a hike now could see that language removed.