Bank of England nears rate peak

The Bank of England raised its policy rate by 25bp to 5.25% today – a downshift from the 50bp move in June, and in line with our and consensus expectations. Indeed, while the accompanying statement left the door open to further tightening, it also added the line that the MPC would “ensure that Bank Rate was sufficiently restrictive for sufficiently long to return inflation to the 2% target.” This suggests to us that the MPC is now confident it is approaching a peak in rates and that it is therefore now shifting the emphasis in its guidance onto the cumulative rate hikes so far and away from further incremental policy moves. This also all-but confirms our previous suspicion that the June 50bp hike was a one-off, which was strengthened by the recent downside surprise in the June CPI data.

Projections show even worse growth-inflation mix – Alongside the policy statement, the BoE also published its quarterly Monetary Policy Report which contained updated projections for growth and inflation, conditioned on market pricing for Bank Rate. Given the significant rise in market expectations for the peak in Bank Rate since the last forecast round in May, the latest forecasts naturally showed a downgrade to GDP forecasts, with the economy now expected to stagnate for longer – growth is expected to be near zero throughout 2024 and 2025, while unemployment is expected to rise by more than previously forecast (with a projected peak now of 4.8% in 2025, up from 4.4% previously, and 4% at present). Interestingly, these worse outcomes for GDP and unemployment contrasted with barely unchanged inflation forecasts for 2023-4, while the inflation forecast for 2025 was raised significantly, to 1.7% from 1.0%. In the press conference, Governor Bailey confirmed that the MPC now judged the upside risks around wage growth and services inflation to have ‘crystalised’, and that the shift in inflation view reflected that wage growth would likely stay higher than inflation expectations-based models suggest – consistent with recent strong wage growth readings. This in turn is likely to keep services inflation more elevated for longer than the MPC previously expected.

We continue to expect one more 25bp hike – All told, the outcome of today’s meeting strengthened our conviction that we will see just one more 25bp hike from the BoE, meaning Bank Rate is likely to peak at 5.50%. Indeed, market pricing for Bank Rate has unwound significantly in recent weeks to move much closer to our view: in early July, markets priced Bank Rate to peak nearer to 6.25%. At the same time, the more hawkish MPC view on wage and inflation dynamics suggests rate cuts are still some way off; we continue to expect modest cuts to start in May of next year, assuming unemployment is rising and inflation is much closer (albeit still above) the BoE’s 2% target at that point.