The Bank of England’s Monetary Policy Committee (MPC) reconvenes this week with the full complement of nine voting members for the first time since March as Dave Ramsden arrives from the Treasury for his first meeting.
Hawks v doves
After the early summer saw fairly hawkish leanings, the market has been discounting any chance that the Bank can hike soon. That seems mainly because the August MPC vote was less hawkish than the previous one in June. But could the Bank be ready to step up the hawkish tone again this week?
At Sintra, governor Mark Carney hinted that he could vote for a hike soon, while also in June chief economist Andy Haldane said he expects to vote for one in the second half of the year. His failure to then vote for one in August was seen as a significant setback to any near-term increase in rates. Muddled messages from Mr Carney further dented bullishness.
The pound dropped sharply after the August 3rd meeting as bulls’ hopes were dashed. GBPUSD shed more than 4 cents to its low of August 24th but has since rallied to a level very close to where it was just before the last monetary policy meeting.
However sterling is still down 2% on a trade-weighted basis since the meeting, which will support the case for a hike to rein in inflationary pressures.
Indeed, while the Aug 3rd vote was assumed dovish by the market given Haldane’s refusal to join the hawks, the messaging from the minutes and from Carney did stress a building tightening bias. The market doesn’t buy it yet but this could be like a dam bursting as pressure gradually builds up before releasing in a torrent. Such internal pressures could result in a surprise hike this week, but is more likely to take the form of more hawkish sounding language. The question is whether the market buys into it this time or decides to disregard.
After the Aug 3rd meeting the Bank said markets may be underestimating how far it needs to raise its benchmark rate over the forecast period. The MPC reckons on two hikes over the next three years, with the first coming in Q3 2018. In the minutes the Bank said that monetary policy could need to be tightened by a somewhat greater extent than financial markets are suggesting. Carney outright in the press conference that one hike over the next three years would not be enough to tame inflation.
Data since August meeting:
Inflation has steadied after cooling in June, which removes any significant pressing need to raise rates. CPI inflation was steady at 2.6% in July having dropped to this level in June from 2.9% in May. Core inflation, which strips out volatile food and energy prices, was likewise static at 2.4% in June and July after being at 2.6% in May. Inflation data on Tuesday (CPI, 09:30) could shift the needle but any change from the previous 2.6% level is likely to be modest and a single month of data will in any event not alter the central projections for inflation regards year-end and 2018/19.
Growth has failed to show any meaningful signs of improvement. GDP expansion was confirmed at 0.3% in Q2 but within this private consumption growth has slowed markedly. Household spending rose just 0.1% in Q2, down from the 0.4% registered in Q1 and well short of the 0.3% forecast. On the plus side, NIESR has upped its forecasts for growth in the three months to August to 0.4% from 0.2% in the previous three month period.
Of particular concern is the spluttering services PMIs. Whether you put any faith in these surveys, there is clearly a concern that growth is slowing. The services PMI for August showed growth in the sector at its weakest in 11 months, with the headline number down to 53.2 from 53.8 in July. The composite PMI reading suggests growth of just 0.3% in Q3. The calculation for the MPC remains simple enough – do you risk choking the recovery at such a precarious time just to tame inflation that is largely exchange rate driven.
Employment remains very strong and there are at long last signs that the tight labour market is feeding through to better wages. Earnings excluding bonuses were 2.1% higher in the April-June quarter, up from 2% in the three months to May and the low of 1.8% in April. With inflation at 2.6% this does still mean real wages are falling, but the pickup in wage growth should be a welcome sign for the Bank and one that could support growing calls for a hike by year-end. REC/KPMG figures last week showed employers raising starting salaries at the fastest pace in two years. ONS average earnings figures on Wednesday will take on added relevance ahead of Thursday’s MPC announcement. These are expected to pick up to 2.3%. Anything above this would be powerfully sterling positive as it would give the MPC hawks added ammunition to correct what some see as the policy misstep of cutting rates a year ago.
Trading since August meeting: Sterling has recovered losses against the US dollar but this is about dollar weakness more than anything else. Against the euro the pound has continued to fall, declining by 1.8% since Aug 3rd and EURGBP is now trading at its weakest since 2009.
Two-year gilt yields have declined from 0.360% at the end of June, when hike expectations were peaking, to around 0.200% in September. Ten-year yields have also declined from above 1.3% at the start of July to 1%.
Forecast: The MPC is all but certain to leave everything well alone, with interest rates to be held at 0.25% and the size of the asset purchase programme unaltered at £435bn. At present there are simply too many unknowns for the Bank to hike to rates. However policymakers are likely to continue to stress that their tolerance for above-target inflation is not unlimited and the market is underestimating their willingness to act.
The vote is expected to be 7-2 in favour of leaving rates unchanged, with confirmed hawks Ian McCafferty and Michael Saunders likely to vote for a hike. Andy Haldane is probably the only real unknown but the chief economist is, on balance, just seen voting for the status quo. If he does vote for a hike, in all likelihood this would be in addition to McCafferty and Saunders, and could be taken as a hawkish signal and be positive for sterling.