Bank of England: Market ignores hawkish vote split

The BOE left rates unchanged earlier today at 3.75%, as expected, however, there was a 6-3 split in favour of remaining on hold, with three MPC members voting for a rate hike. This is up from 2 members in June.

Like the sentiment from last night’s Fed meeting, MPC member Megan Greene justified her decision by saying that inflation has remained above target for 5 years, even though UK CPI moderated in June. The Committee was united in their belief that the risks to inflation are skewed upwards due to energy price volatility. Since the last MPC meeting, the Brent crude oil price is higher by nearly $10, so concern about rising energy prices was to be expected.

For now, the BOE remains on hold, but if we see continued upside pressure on energy prices, then a preemptive rate hike may be necessary down the line, especially if it causes second round effects such as higher wage growth.

However, although there was a hawkish shift in the BOE’s vote split, the BOE’s central inflation forecast was revised down slightly at the top end, they expect inflation to peak at 3.2% in Q4 this year, down from 3.5% in their previous forecast. The BOE’s worst case scenarioincludes a 4% CPI rate for next year, and if oil prices surge back above $100 per barrel, then the BOE expects UK price growth to rise to 4.5% by mid-2027.

Interetsingly, although there was an increase in the number of members voting for a rate hike this month, financial markets are trimming expectations for a rate hike in September. There is now a 40% chance of hike at the BOE’s next meeting, this is down from more than 50% ahead of this meeting.

So, why are rate hike expectations falling in the aftermath of this meeting? We think there are a few reasons:

• Although the BOE remains focused on achieving the 2% inflation target, most MPC members believe that weakness in economic activity and slack in  the UK labour market will keep a lid on second round inflation effects, which is critical if the BOE is going to continue to remain on hold. Although the BOE’s voting intention has become more hawkish compared to June, its inflation forecast fell slightly, which is causing interest rate expectations to fall, Gilt yields to get trimmed and is also weighing on the pound, and GBP/USD has fallen back from earlier highs above $1.34.  
• The BOE said that the UK’s period of disinflation has been disrupted by higher energy prices, although price pressures elsewhere are starting to ease. This has reduced fears that inflation will become entrenched in the UK economy.
• Added to this, the oil price is retreating today, after Wednesday’s sharp jump. Brent crude prices are down more than 1% so far on Thursday, as reports suggest that oil tankers are making their way out of the Middle East, which could ease fears that there will be a supply crunch. The physical flow of oil through the Strait of Hormuz has not been impacted by the attacks between Iran and the US, this could ease inflationary fears at the BOE in the coming months.
• There is also hope that President Trump will need to tone down attacks on Iran in the lead up to the November Midterm elections to ensure oil prices are steady ahead of US voters going to the polls.

Overall, we think that this meeting has solidified the BOE’s ‘active hold’ stance. The Bank has stated that it remains ready to act, if necessary, but we would need to see a sharp deterioration in the inflation outlook for this to happen. Like the Fed, there are a variety of views at the BOE, but for now, the Bank seems to be in the middle of a prolonged pause. Die hard hawks still want rate hikes at both central banks, but the majority are taking a more pragmatic view.

The market impact is lower bond yields, especially in the UK. The 2-year Gilt yield is down 10bps today, as rate hike expectations for the coming months get scaled back. It boosts the FTSE 100, which made a fresh record high today, and weakness in the USD after Wednesday’s Fed meeting may help the pound recover in the medium term.