By Peder Beck-Friis, Portfolio Manager at PIMCO
On Thursday, the Bank of England will announce its next policy decision, along with updated forecasts. We think a +50bps hike is the most likely outcome, though we acknowledge there is a good chance the Bank of England chooses to continue at a +25bps pace.
The market prices the policy rate to peak at 2.75% by early 2023, which we think looks reasonable given the ongoing inflation uncertainty.
- Growth is slowing but not yet breaking. The PMI signaled positive growth in July, unlike in the euro area and the US. The May GDP report was strong (though likely distorted). The external growth outlook has weakened significantly, most notably because of the gas situation in the Euro area.
- The labour market remains tight. Unemployment is low and vacancies are high. Underlying wage growth remains high with no sign of deceleration. Encouragingly, participation has started to recover.
- Inflation is looking more persistent and broad-based. Core inflation was +5.8% (Year-over-Year) in June, down 0.4pts since April, but is not showing any sign of slowing sequentially. Services inflation is rising. Headline inflation is yet to peak, with a scheduled hike in regulated energy prices expected to lift inflation to double-digits in October.
- We expect a +50bps hike on Thursday. At the last meeting, the Bank of England said that it would act “forcefully” if there were signs of persistent inflationary pressures. We think incoming data (accelerating wages, rising services inflation) have supported this, though we acknowledge there is a good chance the Bank of England chooses to continue at a +25bps pace. The weakening growth outlook and falling inflation expectations will likely persuade some Monetary Policy Committee (MPC) members to stick with a +25bps vote. An outsized +75bps hike is very unlikely, in our view.
- We expect the Bank of England to revise near-term inflation higher. The other forecasts will likely look dovish—lower growth, higher unemployment, and lower medium-term inflation, well below target—but we note that these medium-term forecasts have not prevented the Bank of England from tightening policy this year.
- Looking ahead, the Bank of England remains firmly focused on inflation—Bank of England Governor Andrew Bailey has repeatedly said there are no “ifs or buts” in their commitment to bring inflation back to target—and we expect them to continue hiking as long as the labour market remains tight and inflationary pressures are firm, even if activity growth slows.
- The Bank of England is also expected to announce more details on quantitative tightening (QT) on Thursday. Bailey recently noted that the MPC is likely to vote on whether to begin gilt sales, possibly as soon as September. He indicated that gilt holdings could be reduced by 50-100bn in the first year. This is broadly in line with market participant surveys, yet there are still a number of uncertainties, such as: (1) whether active sales will include Gilts in the 0-3y buckets, maturities which were not purchased in the original QE program; (2) whether monthly sales pace would be adjusted to take account of redemption; and (3) how in practice sales would be achieved.
- Active QT may lead the Bank of England to slow down its hiking pace to +25bps in future meetings. But importantly, we do not think the Bank of England will use active gilt sales as the primary instrument to tighten policy.