The Bank of England may have left rates on hold and the vote split may have stayed at 7-2, however, the tone of the statement was definitely more hawkish, and the prospect of a November rate hike is now a real possibility, in our view.
A November rate hike now a possibility
The FX market has run with the statement, ignoring the relatively dovish vote split. Two statements stand out, the first that the market is under-pricing the risk of a rate rise. The second is that the majority of BOE members see scope for some reduction in stimulus in the coming months "if the economy continues to follow a path consistent with the prospect of continued erosion of slack and a gradual rise in underlying inflationary pressure". This sentence is interesting for a couple of reasons:
1, The BOE appears to be happy to reduce stimulus with the economy on its current lacklustre path.
2, The BOE is taking notice of rising inflation and falling unemployment and will tighten policy if this continues, seemingly regardless of wage growth.
Wage growth takes a backseat to inflation and unemployment rate
The BOE is not willing to sit back and let inflation spin out of control at the same time as the unemployment rate falls to its lowest ever level. For the first time in a long time the BOE doesn't seem to be putting wage growth above other inflationary measures as the key metric needed to reach a certain level before the BOE will raise rates. Thus, with inflation expected to top 3% (BOE's latest forecast), we could see a reduction in BOE stimulus even if real wage growth remains mired in negative territory.
Rate hike: when and where?
This statement leaves us with two unknowns: firstly, how will the bank remove stimulus – will it be a rate hike or a balance sheet reduction, or will it be a bit of both. Could we see a series of slow and gradual rate hikes a la Federal Reserve, before the BOE concentrates on its balance reduction programme? Also, what about the timing? We tend to assume that the BOE will make any major move at a meeting when the Governor presents the Inflation Report, which leaves November or February. Surely, if inflation is rising and the labour market continues to create jobs at its current clip then November could be key?
Market repricing chance of a hike before year end
The Overnight Index Swap market, which is a good gauge of market interest rate expectations, has rushed to price in a chance of a rate hike in November, it now expects a 41.5% chance of a hike in November up from 18% just last week.
GBP: $1.35 now on the cards
This rapid repricing of UK interest rate expectations has fuelled a sharp sterling rally in the aftermath of the BOE decision. GBP/USD has surged 100 points in the aftermath and is now above 1.3310, surely if the US CPI disappoints later today than $1.35 will be on the cards for GBP/USD? EUR/GBP has also reversed previous gains and is now below 0.90, after making a fresh 6-week low.
The pound has been in favour for the last month, even though inflation outpacing wage growth should make UK asset prices unattractive. However, the FX focus is all about central banks, and today's meeting marks a shift to the hawkish side for the BOE, and the real possibility of a rate hike in November.
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