Finance Monthly. 7 The Monthly Round-Up THE MPC SETS THE BAR HIGH FOR FURTHER RATE HIKES The Bank of England’s Monetary Policy Committee voted 7-2 to raise Bank Rate by 25bps to 4.5% at the May meeting today. The increase was in line with both our forecast and market expectations. The minutes effectively left the criteria for additional rate hikes unchanged, requiring evidence of more persistent inflationary pressures to justify tightening again. But at the same time, the BoE adopted a stronger forecast for GDP and a lower projection for unemployment. And though it lowered its near-term inflation profile a little, it remains much higher than our forecast (Chart 1). Indeed, if we are right, the Q2 figures will represent the largest one-quarter ahead undershoot of the BoE’s forecast in history. What’s more, the consensus forecast for inflation in Q2 is even lower than our own. Therefore, the scope for key data to surprise to the upside of the MPC’s forecast looks quite limited. So, if the MPC remains consistent with its guidance, then 4.5% should represent the peak for Bank Rate. While the MPC’s message about the near-term outlook for rates appeared dovish, its forecasts suggest rate cuts are likely some way off. The BoE brought its 2023 growth forecast into line with our own (Chart 2), while it now expects unemployment to remain close to current levels rather than rising significantly, implying that the labour market will remain tight. The MPC has become slightly less pessimistic about the outlook for supply, as it has adopted a new set of ONS population assumptions and factored in the impact of Budget reforms aimed at increasing participation. Together, these changes have raised its estimate of the level of potential supply by just over 1ppt in three years’ time. But this still represents a weaker forecast than our own, and it is much softer than the OBR’s projection. So while the BoE’s higher inflation forecast for H2 2023 is a function of higher food prices, its higher inflation projections further out reflect stronger demand combined with the MPC’s rather pessimistic take on supply, meaning that a much smaller degree of spare capacity is expected to emerge. The MPC also repeated its line from February that the risks to the inflation outlook are heavily skewed to the upside, reflecting the possibility that second-round effects on wages and prices might take longer to unwind. Given the risk profile and that the MPC maintains a rather pessimistic view on supply, it’s hard to see the majority swinging towards active consideration of rate cuts anytime soon. For the MPC to get to that stage, it will need to see inflation fall much lower, wage growth falling back significantly, and evidence that labour market conditions have loosened sufficiently. We think such signals are unlikely to emerge until at least early-2024, with the risks skewed towards rates remaining on hold for longer. Finally, the minutes revealed that the unwind of the BoE’s corporate bond purchases was well ahead of schedule. Only £2.7bn of the original £20bn stock of purchases are still held by the BoE and, apart from a small number of very short maturity bonds, the remaining bonds will be sold in the next few weeks. This will mean the unwind is completed well ahead of the longstanding deadline of end-2023.
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