BOE Hike Warnings Clash With Global Slowdown: Decision Day Guide

(Bloomberg) -- Go inside the global economy with Stephanie Flanders in her new podcast, Stephanomics. Subscribe via Pocket Cast or iTunes.

The Bank of England must decide whether to temper warnings of future interest-rate hikes as investors and other major central banks prepare for more policy easing.

While the Monetary Policy Committee is expected to keep the key rate unchanged on Thursday, Citigroup predicts some votes for an immediate increase. Officials, led by Governor Mark Carney, may choose to repeat their mantra that a few rate rises are needed to control inflation, putting them at odds with investors who are pricing a greater chance of cuts in coming years.

While the bank’s guidance assumes a smooth Brexit, traders see a bumpier road. The BOE is also meeting in a week where other central banks have taken a decidedly dovish turn. The U.S. Federal Reserve’s decision Wednesday showed some officials expect rates to go down later this year, while European Central Bank President Mario Draghi pledged new stimulus if the outlook doesn’t improve.

The global slowdown is one reason why Carney’s warning that the market isn’t pricing in enough future increases fell on deaf ears. Investors overlooked recent hawkish comments from Michael Saunders and chief economist Andy Haldane -- who said the time is nearing when a hike is needed to keep inflation pressures in check.

Forward Curve

Indeed, since the May Inflation Report, traders have become even more pessimistic and are now pricing in some BOE easing over the next three years, rather than the modest tightening they saw in May.

Little Worse

The other factor behind the shift lies in the U.K.’s own prospects. Speaking last week MPC member Gertjan Vlieghe said global and domestic risks had intensified in the past month and the outlook “has got a little worse” since the BOE’s May forecast.

That was particularly highlighted by a June 10 report that showed the economy shrank for a second straight month in April, as the evaporation of a boost from Brexit stockpiling and planned car shutdowns pushed down manufacturing output by the most in almost 17 years.

Brexit Approaching

Political turmoil also persists, with the outcome of the U.K.’s Brexit process increasingly unclear. The uncertainty hasn’t improved with the resignation of Prime Minister Theresa May. The BOE will announce its decision just hours before the Conservative Party whittles the race to replace her down to a final two candidates.

While the BOE’s forecasts remain rooted in the assumption of a smooth Brexit process, investors can be more reactive, and so have increasingly priced in the risk of a no-deal departure under a new government in October.

What Bloomberg’s Economists Say

“Despite some policy makers warning that the BOE can’t be held hostage by Brexit uncertainty, we doubt the central bank will move until the fog has cleared.”
--Dan Hanson, U.K. economist. See his BE PRIMER

Slowing Inflation

The outlook for inflation may also give officials pause for thought. The headline rate fell back to the BOE’s 2% target in May, and policy makers expect it to drop below their goal this year, giving them breathing space to keep interest rates on hold.

Low Unemployment

The bright spot for the U.K. economy -- and the source of the BOE’s hawkish bias -- remains the labor market. A report last week showed the number of people in work rose more than forecast in the three months through April, and basic pay growth unexpectedly accelerated to 3.4%.

--With assistance from Jill Ward and Lucy Meakin.

To contact the reporter on this story: David Goodman in London at dgoodman28@bloomberg.net

To contact the editors responsible for this story: Paul Gordon at pgordon6@bloomberg.net, Brian Swint, Fergal O'Brien

©2019 Bloomberg L.P.