Divided Bank of England pushes back on aggressive rate expectations

The division on the MPC reflects the policy tightrope the Bank continues to walk, as it balances the need to keep inflation expectations well anchored, amid what is still a largely supply side-driven surge in inflation, against the growth-dampening hit to real incomes, and the ever present risk of a Russian gas cut-off. Indeed, Governer Bailey in the press conference underlined the predicament facing policymakers, as he noted the UK labour market faced similarities to the US in the degree of tightness we are seeing, but also similarities to the eurozone in terms of the energy supply shock the economy is facing. In striking a balance between those on the MPC advocating for more aggressive rate hikes to combat inflation with more dovish members, the forward guidance on rates was - in substance - largely unchanged from February, with the Bank stating that 'some degree of further tightening in monetary policy might still be appropriate in the coming months', although there were 'risks on both sides of that judgement and a range of views among these members on the balance of risks'.

The Bank also today published an update to its quarterly projections for the UK economy. The Bank raised its near-term inflation forecast, with inflation now expected to peak at around 10% when Ofcom next raises the household energy bill cap in October. Crucial for us, and for the path of monetary policy, is where the Bank sees medium term inflation. As we flagged in our preview on Monday, conditioned on the steep rise in rates expected by financial markets, the Bank projects an even bigger undershoot of its inflation target three years out, with inflation expected to fall to 1.4% in Q1 2025 vs 1.6% in its February projection. This assumes Bank Rate peaks at 2.5% in 2023 (in line with market pricing until today) as compared to 1.4% in the February projections. Meanwhile, GDP growth is projected to slow sharply, to recession-like levels by Q2 2023 (0% vs 1.2% in the February projection), while unemployment is projected to rise by nearly two percentage points by Q2 2025, to 5.5%.

The updated projections and the ambiguous guidance on rates continues to stand in contrast to market expectations for further significant policy tightening, though some of those expectations saw a major unwind following today's announcement: market expectations for Bank Rate fell around 25bp to 2.1% by end-2022, and sterling fell by close to 2% vs the dollar. Following today's updated guidance and projections, we add one further rate hike to our profile, and now see Bank rate peaking at 1.5%, reflecting the balance of risks around growth and inflation. We expect these hikes to be front-loaded, at the June and August policy meetings. Thereafter, we expect the balance of opinion on the MPC to shift in favour of the doves, as the risk of recession begins to weigh more heavily in policy deliberations than the risk of a drift higher in inflation expectations.