The Bank of England today voted 8-1 in favour of raising Bank Rate by 25bps to 0.75%, marking the third successive rate hike since the December meeting. The decision was underwhelming for market participants, however, as the sole dissenter, John Cunliffe, voted to hold rates.
This is a stark comparison to February’s meeting where the voting split was 5-4 in favour of a 25bp hike, with the three dissenters voting for a larger 50bp move. After the initial announcement, GBPUSD plummeted back below the 1.31 handle, front-end Gilt yields fell, and money markets priced out the probability of a 50bp hike in May as the Bank’s preference for incrementalism became apparent. Money markets not only began pricing out larger hiking increments, but also began to lower their projected estimate of the year-end rate.
The implied December 2022 policy rate now sits below 2%, down from 2.2% prior to the meeting.
GBPUSD drops below the 1.31 handle as markets price out the probability of larger rate hike increments and a flatter hiking profile from the BoE
Throughout the meeting minutes, MPC members stressed that events since the February meeting have accentuated both the peak in inflation and the adverse impact rising CPI will have on activity via the squeeze in household incomes.
The latter point emboldened MPC member Cunliffe to vote in favour of holding rates as he now deems the demand shock sufficient enough to act as a natural headwind to inflation over the course of the two-year horizon. However, with inflation expectations rising, as outlined in the latest BoE/ Ipsos survey, most MPC members opted to take out insurance against second-round effects of rising headline CPI by raising Bank Rate to 0.75%. Suggestive of the focus on the inflation impact of events in Ukraine over growth, the rate statement maintained language over that “further modest tightening in monetary policy may be appropriate over the coming months”. This suggests, along with the strength of recent labour market and GDP data, that the Bank will go for four-in-a-row in May and will vote to bring rates up to 1% – the point in which active sales of assets will be discussed among MPC members. We have long argued that the path to 1% will be fairly navigable, even despite the recent geopolitical developments, however, the decision to alter policy will become increasingly more difficult thereon in.
Concerns around the erosion of household real incomes will likely factor in to a greater degree at this point, especially if medium-term inflation expectations remain stable despite the rise in CPI in April to above 8%.
For sterling traders, rate differentials will now become a tricky dynamic to factor in. With markets likely to continue flattening the implied path for rates this year, especially as more caution becomes visible in MPC communications, and the Federal Reserve likely to prioritise tackling the inflation shock more aggressively, headwinds for GBPUSD bulls in the second half of this year are likely to appear. Without a material reduction in global commodity prices and fiscal support to the growth outlook from the March budget, rate differentials are likely to widen in favour of the dollar over this period. Domestically, labour market and inflation expectation data will prove key for assessing this medium-term outlook for GBPUSD. For now, we are placing our medium-term forecasts under review.
Simon Harvey, Head of FX Analysis