State of Play: BOE MPC Vote Hike Split To Drive Guidance

By David Robinson, Senior BOE Correspondent

     LONDON (MNI) - The number of dissenters to the widely-anticipated start of

the Bank of England's rate tightening cycle at next Thursday's Monetary Policy

Committee meeting will frame market perceptions about how far and how fast

tightening goes. It will also help determine when the spotlight returns to the

MPC's approach to unwinding its stg435 billion pile of gilt purchases.

     It is unsurprising that markets have been placing a high probability, of

close to 90%, on a hike next week. Analysts see a seven-to-two vote for

tightening as the most likely outcome, but the chance is there for more than two

dissents. The scale of dissents is likely to play into any steer - or none - the

MPC may give about another near-term hike. 

     Similarly, the degree of MPC disunity will be factored into the timing of

new guidance of QE unwinding.

     The MPC is due to revisit its guidance that unwinding QE won't start until

Bank Rate is raised to around 2.0%, with Governor Mark Carney outlining a case

for lowering that trigger, though it would be a surprise if new guidance were

issued at the 2 Nov. meeting or, indeed, this early in the tightening cycle.

     The MPC's current guidance was issued back in the November 2015 Inflation

Report. A box in that report stated that the MPC expected to maintain its stock

of asset purchases until Bank Rate had reached a level from which it could be

cut materially. "Based on historical experiences, the MPC currently judges that

such a level of Bank Rate is around 2%," that report said.

     The theory is that Bank Rate should again become the active policy

instrument, allowing the MPC scope to cut it if things took a turn for the worse

while only using QE in exceptional circumstances.

     The catch is that on current rate expectations Bank Rate will not get to

within touching distance of 2% over five years, entailing no unwinding of QE

whatsoever in the tightening cycle unless the MPC revises its guidance.

     Research within the Bank backed unwinding QE early in the tightening

process rather than late. While MPC members still appear wedded to the idea of

hiking Bank Rate first there is an awareness that the 2.0% level may need to be

lowered and that the whole approach needs to be reassessed.

     "I definitely think it is important that we start talking about how to

carry out that unwinding," MPC newcomer Silvana Tenreyro told the Treasury

Select Committee (TSC) on Oct. 17.

     Carney, appearing after Tenreyro at the TSC, was asked if he thought QE

unwind would begin before his term ends in June 2019. He declined to speculate

but did sketch out a case for lowering the 2.0% unwind threshold to around 1.5%.

     "It would be better to be in a position where we got Bank Rate up to a

level where you could run through an average interest rate cycle. With the

exception of the drop in interest rates post the financial crisis, in this

country, it has been about 150 basis points on average since the advent of

inflation targeting in 1993," Carney said.

     On this logic, the MPC would want to raise Bank Rate to at least 150 basis

points above the effective zero lower bound (ZLB) to give it scope to deal with

a typical downturn. When the MPC cut Bank Rate to 0.25% in August last year it

stated that the ZLB was below 0.25%, but likely still positive - making around

0.1% a best guess. So the QE unwind threshold could be lowered to around 1.5%.

     The MPC will also be watching closely how yield curves have been reacting

to the start of QE unwinding in the US. The evidence so far suggests little

impact on term premia - which would add to the MPC's confidence that it could

start unwinding without bringing about a sharp tightening in financial

conditions.

     One option for the MPC, rather than selling back its gilt hoard to the

market, is to let the gilts it holds reach maturity.

     "My inclination, and again I am speaking for myself, would be to proceed

gradually. Now, how gradually? The extreme of gradually is something where you

just let the gilts expire. In seven to eight years' time from now, half of the

stock will be completely absorbed," Tenreyro said.

     A problem with this line is that the MPC's current guidance is that it is

committed to replacing maturing gilts until unwinding begins at around 2%. So

the natural, gradual rundown that Tenreyro described would not even begin over

the next five years if market rate expectations prove right.

     The MPC's guidance on QE unwinding has evolved through Inflation Report

forecast rounds. The MPC may be disinclined to risk rocking markets with a

double hit of a rate hike and a lower threshold for QE unwinding on Thursday but

the 2% threshold is already looking obsolete.

     Asked by the TSC when the QE unwind should begin, new Deputy Governor David

Ramsden replied when Bank Rate had been raised to a level from which it could be

materially cut. He was no more forthcoming when he added:"That is a higher level

from the level it is at now."

     -Dissenting Minority Could Be Up To 4

     If the MPC does impose its first hike since July 2007 on Thursday,

attention will turn to whether the committee or Carney at the subsequent press

conference offers any steer on whether another near-term hike is likely.

     The Bank's most recent quarterly forecasts, published back in August, were

conditioned on the market assumptions, derived from the OIS nominal forward

curve, that Bank Rate would rise from 0.25% to a touch over 0.7% by 2019. That

forecast showed inflation holding above the 2.0% target throughout the three

year forecast horizon, implying that more than the two 25 basis point hikes the

market was pricing in would be required.

     Since then market rate expectations have shifted higher. The most recent

OIS curve published by the Bank shows Bank Rate rising gently to 0.9% two years

out, then up to a sliver over 1% in three years and to just below 1.3% five

years out, with the second hike priced-in by August next year.

     If the MPC is divided over the November hike, and as members will want to

see what impact it has, the inclination will be to avoid endorsing another

near-term hike, with the committee revisiting the issue in the next quarterly

forecast and policy round in February.

     As generously signalled, the MPC is poised to hike Bank Rate next Thursday

by 25 basis points from its current 0.25% level but there are likely to be at

least two dissenters - Deputy Governors Jon Cunliffe and Ramsden, both ex-UK

Treasury mandarins - and question marks hang over the votes of a couple of other

members.

     With the exception of Ben Broadbent, Deputy Governor, Monetary Policy, the

other eight MPC members have publicly set out their views in recent days and

weeks.

     Cunliffe and Ramsden both made clear that they dissented from the view of

the majority on the MPC at the September meeting that a rate hike was likely to

be justified in "coming months."

     Ramsden at his appointment hearing with the Treasury Select Committee (TSC)

on October 17 said "a majority of MPC members saw a case for removing some

monetary stimulus in... 'the coming months'. I was not in that majority."

     A dividing line between MPC members is over the likelihood of earnings

growth accelerating, with diminishing slack and robust employment growth so far

failing to trigger any pronounced rise in pay. Ramsden is unconvinced that

shrinking spare capacity will see higher pay growth.

     "You would have expected the small degree of spare capacity we have to have

triggered stronger wage growth, but basic pay ... is about 2.1% on a year

earlier," he said.

     Cunliffe noted the weakness in pay growth in an October 23 interview. He

said that UK economic growth had slowed this year "because of the squeeze we

have seen on real incomes and imported inflation from the (sterling)

depreciation that has come in. And pay has remained relatively subdued."

     While interest rates will eventually need to rise, "The exact timing of

when that starts? Well, that for me is a more open question," Cunliffe said,

declining to echo the "coming months" line.

     Another possible opponent of a rate hike in November is Tenreyro. At her

appointment hearing at the TSC she endorsed the "coming months" line and

predicted earnings growth would pick-up but also stressed that her decision

depended on how the data unfold, which could tilt the scales towards waiting a

little longer before backing a hike.

     "If the data outturns are consistent with ... an output gap going towards

zero, I would be minded to vote for a bank rate increase in the coming months.

However, that is very contingent ... If the data undershoot ... then I will wait

until I see firmer evidence of that output gap being eroded," she said.

     Two votes for a hike when the policy decision is announced on November 2

can be taken for granted, with Ian McCafferty and Michael Saunders having

supported tightening at the previous MPC meeting.

     Gertjan Vlieghe, in a speech back on September 15, endorsed the "coming

months" line and Governor Mark Carney reaffirmed his support for it in a CNBC

interview on October 13.

     If Carney, McCafferty, Saunders and Vlieghe all go for a hike it would need

just one more member on the MPC to get a majority.

     Chief Economist Andy Haldane was an early supporter of likely tightening in

2017, saying back in June that if the data stayed on track "beginning the

process of withdrawing some of the incremental stimulus provided last August

would be prudent moving into the second half of the year."

--MNI London Bureau; tel: +44 203-586-2223; email: david.robinson@marketnews.com

[TOPICS: M$B$$$,M$E$$$,MX$$$$,M$$BE$]