BoE Preview - MPC to steer a further pricing out of rate hikes

Market expectations for rate hikes have been dialed back significantly following the dramatic fiscal policy U-turns and the formation of the new government under PM Rishi Sunak – Bank Rate was as little as a month ago priced to peak at near 6% in 2023, whereas it is now expected to peak at 4.75%. Market expectations have persistently overestimated the degree to which the Bank of England would hike rates, and despite the significant repricing, we think the Bank’s projections are likely to show a deep recession and inflation falling well below the Bank’s 2% inflation target in the medium term – therefore signaling that market expectations for rate hikes remain too elevated. Our base case is for Bank Rate to peak at 4% in early 2023.

Forward guidance muddied by the fiscal outlook – While on balance we expect the BoE to surprise markets to the dovish side if anything, the degree to which it can provide clear guidance to markets is held back by uncertainty over just how much fiscal policy will be tightened over the coming years. The government will provide an update on its fiscal plans on 17 November, but early indications are that they will contain significant spending cuts and tax rises, and to a greater degree than we previously assumed. The MPC will want to wait, therefore, until it sees the full package of measures before it indicates what this will mean for monetary policy. A significantly tighter fiscal stance does, however, imply that monetary policy will not need to be tightened as much as it otherwise would, given the growth and inflation dampening effects that spending cuts and tax rises are likely to have.