We expect the Bank of England (BoE) to raise the policy rate by 25bps tomorrow, hot on the heels on last week’s policy announcements from the Fed, the European Central Bank (ECB) and the Bank of Japan (BOJ).
The Fed may be already done with its tightening cycle and the ECB may have one more hike in the pipeline. Either way, both central banks are very close to ending some of the most aggressive tightening cycles in recent history. But we think the BoE still has further to go in tightening policy. Meanwhile the BOJ has begun normalizing policy from ultra-accommodative settings at a very gradual pace.
June’s unexpected acceleration in the pace of BoE rate hikes from 25bps to 50bps followed increasing signs that inflationary pressures were more persistent than economists had anticipated, with a tight labour market and wages continuing to rise.
However, we have now seen a reversal of fortunes in the June inflation data, as headline and core inflation decelerated significantly, falling below expectations. This was also supported by the surprise 50bps hike in the last meeting which helped the BoE regain credibility, supporting the pound and therefore help dampen inflationary pressures.
Markets are now pricing in a slightly higher increase of ~32bps, markedly slower than the ~78bps priced in just before the last meeting in June. Similarly, market terminal rate expectations have been revised lower from 6.5% in June to 5.8%, which is in line with our expectations.
The BoE’s job is far from done. The transmission of monetary policy to financial conditions and consequently to the economy is taking longer than anticipated. This is not to say that the transmission channel is broken: the impact from tighter policy will be felt more acutely as real rates across the curve turn positive and as higher mortgage costs dampen household spending.
We expect the UK economy to enter a recession in H1 2024 as the BoE maintains a tight policy for longer.
