BOE Watchers Look for Signs of Tightening Ahead: Decision Guide

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The Bank of England on Thursday may add fuel to investors’ expectations that its next move will be to tighten monetary policy rather than provide fresh stimulus to the economy as the pandemic eases.

The U.K. central bank is set to significantly upgrade its growth outlook as the debate shifts away from whether it should cut interest rates below zero to how fast can the economy recoup its pandemic-induced losses. A forecast for inflation around its 2% target within the next two years could be read as an endorsement to growing expectations that interest rates are headed higher, according to Bloomberg Economics.

Economists expect the central bank’s Monetary Policy Committee to keep rates and bond-buying targets to remain unchanged at noon in London. Many also expect any inflationary surge this year to be short-lived and point to BOE’s statements that it needs to see a sustained rise in prices before pulling back stimulus. That hasn’t stopped investors from pushing up market-based rates, driven by the U.K.’s successful vaccination drive.

“Despite the faster recovery, we expect the MPC to forecast inflation remaining around target over its forecast horizon,” Dan Hanson at Bloomberg Economics wrote in a preview of the decision. “That will provide validation for pricing by financial markets.”

Inflation has remained below the bank’s 2% target for 1 1/2 years, leaving Governor Andrew Bailey room to wait before acting.

The nine-member MPC is expected to vote unanimously to keep their benchmark interest rate at a record low 0.1% and the asset-purchase target at 895 billion pounds ($1.2 trillion) at midday in London, according to a survey of economists by Bloomberg.

The BOE has been buying about 4.4 billion pounds of government bonds a week -- a pace that would see the program reach its overall target at the start of November.

Some investors expect officials to announce on Thursday that they will slow the rate of buying so that the program stretches to the end of the year instead of ending abruptly. Most other expect no change and will look to Bailey’s press conference and minutes of the meeting for signs of when policy makers might act.

“The most I expect, really, is maybe an acknowledgment in the language that the recovery has been very strong, probably ahead of expectations,” said Shamik Dhar, London-based chief economist for BNY Mellon Investment Management.

Earlier this week, U.S. Treasury Secretary and former Federal Reserve Chair Janet Yellen ruffled markets saying, “it may be that interest rates will have to rise somewhat to make sure our economy doesn’t overheat.” She later clarified that she wasn’t forecasting rate increases.

For the BOE, a decline in the pace of purchases wouldn’t impact the total amount of stimulus reaching markets, unlike the tightening seen last month by the Bank of Canada. Even so, there’s signs the BOE is preparing for broader action. In February, Bailey asked staff to review how the BOE might unwind its stimulus measures.

Financial markets have responded to signs that the U.K. economy is bouncing back from its worst slump in three centuries. The yield on the U.K. government’s 10-year bond was over 0.81% on Wednesday, near the highest since before the start of the pandemic. Traders have priced in 12 basis points of rate increases in August 2022 compared to about 6 points a little over a week ago.

Much has changed in the U.K. since the BOE’s last forecast round in February. The economy took less of a hit than expected in during the lockdowns to control the coronavirus. Analysts surveyed by Bloomberg expect growth of 5.5% this year, above the 5% pace forecast by the BOE in February. Bloomberg Economics expects a 7% expansion.

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“With the vaccination program showing little sign of slowing, that’s likely to mean growth is more front-loaded this year compared with the central bank’s February projection. But with the recovery still in its infancy, the central bank is likely to stress there’s a higher than usual bar for tightening policy and that it’s ready to loosen again if needed.”

-- Dan Hanson, Bloomberg Economics. Click here for the full PREVIEW

The new projections will also likely reflect a lower peak in post-crisis unemployment. Previously, the BOE expected the jobless rate to touch 7.8% in the third quarter, but in March, Chancellor of the Exchequer Rishi Sunak extended furlough payments for workers thorough September.

The strength of the recovery dependents on households’ willingness to dip into the 150 billion pounds of savings they accumulated when shops and restaurants were closed for lockdown. But some analysts, notably the central bank’s Chief Economist Andy Haldane, worry that higher inflation is around the corner.

“The bias will be to keep monetary policy relatively loose and we’ll want to see the whites of inflation’s eyes before we start to raise dramatically,” said Dhar, the economist from BNY Mellon. “That that induces a bias toward maybe overshooting compared with undershooting.”

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