BOE’s Hawkish Push Turns Rate Decision Into Credibility Test
Bank of England policy makers are heading into their meeting this week knowing that failure to deliver a once-unthinkable interest-rate hike would now raise serious questions over their credibility with markets.
Investors are almost fully pricing in a 15-basis point increase in the benchmark lending rate on Nov. 4, while economists increasingly share that view, even as they see the decision as a far closer call.
A rate rise in the U.K. would be the first since the pandemic from a central bank in the world’s leading economies. It would mark a far quicker move toward normalization than in the aftermath of the global financial crisis more than a decade ago. It’s a response to a surge in inflation that the BOE expects will linger at more than double its 2% target well into next year.
“After effectively signaling for a few weeks that a rate hike is imminent, to not do so this year risks damaging the BOE’s credibility, something it will be keen to avoid,” said Stuart Cole, head macro economist at Equiti Capital and a former U.K. central bank official. “The BOE has not pushed back on market pricing, suggesting tacit approval for tighter financial conditions.”
The speed of the change in narrative is remarkable considering that when policy makers last met in September, investors and economists saw barely any chance of action this year. Since then, Governor Andrew Bailey has voiced increasing concern about rising prices and signaled the bank “will have to act.”
Economists see the Nov. 4 decision as a very close call, with a Bloomberg survey showing 51% forecast a hold and 49% a hike. In a sign of the uncertainty ahead of the decision, analysts have predicted five different potential vote splits. Of those seeing no change, most expect officials to split 7-2 in favor of staying put.
Still not all of the nine-member committee share that view, suggesting the decision could be far more uncertain than markets think. Two members have appeared to rule out a move. Three have stayed silent and could yet opt for no change. And even chief economist Huw Pill, who has predicted inflation could top 5%, says the call this month is “finely balanced.”
What Bloomberg Economics Says ...
“There’s a fierce debate raging on the Monetary Policy Committee about whether to raise interest rates next week. Financial markets think it’s a done deal, thanks to a series of hawkish interventions by Governor Andrew Bailey. We’re less sure. Our baseline is the MPC holds, teeing up a hike for December, assuming the end of the furlough scheme doesn’t knock the labor market off course.”
--Dan Hanson, Bloomberg Economics. Click for the full PREVIEW.
That’s left the divided BOE in a bind of its own making. Bailey has declined to push back against market speculation of an imminent move. Not delivering on Nov. 4 could touch off a barrage of criticism of the central banks’ communication, with disgruntled investors caught on the wrong side of the trades questioning the BOE’s credibility. Bailey’s predecessor Mark Carney was branded the “unreliable boyfriend” during one such episode.
“Our call for a rate hike next week is finely balanced, with the committee likely to be split on the decision,” said Deutsche Bank economist Sanjay Raja. “We expect a 6-3 vote tally in favor of a rate hike” but “we see a non-negligible risk that a lift-off may be delayed to December.”
But acting could also have consequences. By increasing the focus on November, officials will now need to make the decision before seeing labor market data that will show the impact of the end of the government’s pandemic jobs support program, a crucial piece of the jigsaw in the U.K.’s recovery. Throw in the prospect of a very difficult economic winter in the U.K., against a back drop of rising prices, taxes and virus cases, and some are worried the BOE is at risk of focusing too much on inflation-fighting credibility and heading for a policy mistake.
Bailey’s hawkish turn has also led to traders pricing in rate path that puts the central bank on course for the fastest tightening of policy this century. That would involve a move from 0.1% this week followed by a swift cycle of increases that would put the key rate at 1.25% by the end of 2022.
There’s also the issue of what to do with the BOE’s bond buying plan, which is due to run until the end of the year.
Keeping it going after raising rates might send a confusing message. But ending it, as suggested by some banks, would go against previous guidance and may give markets reason to doubt future programs. Coming so soon after a budget that saw borrowing predictions slashed, it might reawaken accusations that QE only existed to fund the government’s pandemic spending.
If the BOE were to push back against that outlook for tightening, possibly through weaker long-term inflation forecasts, it could also have consequences for markets, and prompt questions over how officials lost control of the yield curve in the first place.
“We doubt that there will be a majority at the MPC for a change in rates next week and think that the BOE will struggle to meet the already very hawkish market expectations,” said Valentin Marinov, head of G10 FX strategy at Credit Agricole.
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