United KingdomHawkish MPC signals aggressive pace of rate hikes

Contact: Andrew Goodwin | agoodwin@oxfordeconomics.com 3 Feb 2022 Research Briefing | UK Hawkish MPC signals aggressive pace of rate hikes Economist Andrew Goodwin Chief UK Economist +44(0)20 3910 8013  Alongside its decision to raise rates by 25bps to 0.5%, the MPC today sent an unmistakeably hawkish message, and we now expect further 25bp hikes in March and May, followed by another 25bp increase in H2. But in our view, the MPC’s aggressive approach is not consistent with the data nor with the sizeable downside risks to growth.  The BoE also signalled the start of quantitative tightening – we expect the BoE to be selling both gilts and corporate bonds by mid-2022. However, the macroeconomic impact of asset sales should be limited. The MPC voted 5-4 to raise Bank Rate from 0.25% to 0.5% today, with the four dissenters preferring a larger rise of 50bps. The MPC had previously said it would cease reinvesting maturing assets when Bank Rate reached 0.5%, and it confirmed it would stick to this plan. It also announced its aim to reduce its £20bn stock of corporate bonds via a programme of asset sales that will be completed by the end of 2023 at the earliest. In our preview, we noted that it was hard to predict the outcome of today’s meeting given that only two members had made any public comment since the December hike. It’s now clear that all members have turned significantly more hawkish in the past seven weeks, particularly around the risk of a tight labour market causing a sustained period of high inflation, even after the temporary pressures from high energy and global goods prices have faded. These fears appear to be largely based on feedback from the BoE’s regional agents and its Decision Maker Panel, information that led the MPC to raise its forecast for wage growth in Q4 2022 from 1.25% to 3.75%. The MPC’s argument is that tighter monetary policy will help to rein in inflation and wage expectations. But it’s far from clear that this is needed given the scale of the real income shock already facing households this year from surging energy prices and tighter fiscal policy. The MPC had two distinct messages. First, though it has implemented the first back-to-back rate hikes since 2004, more rate rises are to come in the near-term. Second, it still thinks that rates are unlikely to rise as high as market pricing implies further out. This is demonstrated by its forecasts that show inflation moving ever further below target and a widening degree of spare capacity emerging. Figure 1: The MPC signalled a series of rapid rate hikes in the near-term, but still sees market expectations as being too aggressive further out -1.25-1.00-0.75-0.50-0.250.000.250.500.750123456782019202020212022202320242025CPI inflation (LHS)Excess supply/excess demand (RHS)UK: BoE forecasts for CPI inflation & excess supply/excess demand*% yearSource: Bank of England Monetary Policy Report, February 20222% target% of potential GDP* based on market interest rate expectations Page 2 Contact: Andrew Goodwin | agoodwin@oxfordeconomics.com Still, the clear message from today’s minutes and press conference is that further rate hikes are on the way. Indeed, the paragraph in the minutes summarising the views of the majority suggested that these members believed a bigger rise in Bank Rate was warranted, but that they preferred to move at a slower pace to prevent financial conditions from tightening more than is desirable. So after back-to-back rises in December and February, we now expect further 25bp rate hikes at the March and May meetings, taking Bank Rate to 1%. But after an initial flurry of rate hikes, we expect a calmer period in H2 2022 and beyond. The MPC’s forecasts are based on market interest rate expectations that show Bank Rate rising to 1.4% by early-2023. But the MPC signalled that it views this profile as being too aggressive, with its inflation forecast moving ever further below the 2% target in the latter part of the forecast horizon and a large amount of spare capacity emerging (Figure 1). Indeed, these inflation forecasts are boosted in the latter years by the MPC’s convention of keeping energy prices constant after six months; had the MPC based their projections on the futures curves throughout, not just for the first six months, CPI inflation would be just 1.2% at the end of the forecast period. If, as we expect, the inflation outlook begins to calm, we think there will be just one 25bp rate hike in H2 2022, meaning Bank Rate ends the year at 1.25%, and no hikes at all in 2023. Indeed, should the downside risks to growth begin to crystallise, the MPC may not hike in H2 2022 either. As well as signalling a faster pace of near-term rate hikes, the MPC also began the process of quantitative tightening. £27.9bn of gilts held by the BoE are due to mature on March 7, and the proceeds will not be reinvested. And with Bank Rate now set to hit 1% by May, we are fast approaching the poi