BoE: T-minus 15 basis points and counting

Summary

U.K. inflation eased slightly in September, although that will likely prove to be a temporary lull given the recent rise in energy prices and signs that underlying wage growth is firming. Expect a further quickening of CPI inflation in the months ahead. In contrast, economic growth has been somewhat uneven and could remain so for the time being.

By themselves, growth and inflation trends don't offer an open-and-shut case for an imminent rate hike. However, in the context of increasingly hawkish comments from Bank of England (BoE) policymakers, we think today's CPI will be enough for a November interest rate lift-off, and a gradual pace of rate hikes thereafter. We expect a 15 bps hike in November, followed by a 25 bps hike in May 2022 and a further 25 bps hike in November 2022.

Our forecast for BoE monetary tightening is more gradual than currently anticipated by market participants. As a result, the pound could face some downside, for now, and there may also be some mild downside risk to our forecast of GBP/USD appreciation over the medium-term.

Houston, we have an inflation problem

The release of the U.K. September CPI revealed a slight lull in what has nonetheless been a growing inflation problem for U.K. policymakers. Headline inflation eased to 3.1% year-over-year (still above the upper end of the central bank's inflation target range), while core CPI inflation slowed to 2.9%and services inflation slowed to 2.6%. The slowdown, however, was in part due to base effects stemming from restaurant & cafe inflation, which made a smaller contribution to overall price inflation. Restaurant & cafe prices rose in September 2020 as the U.K. government ended its "Eat Out to HelpOut" program, a price increase that was not repeated in September 2021. However, the lull of inflation will likely be brief. The recent rise in energy prices, specifically stemming from higher natural gas prices, should be reflected in October, while underlying wage growth appears to be firming. CPI inflation still appears on track to peak at or above the Bank of England's (BoE) forecast of around 4%.

While inflation still appears to be on a fairly clear upswing, the pace of economic growth appears to be moderating. The latest news on that front was August GDP data which showed a GDP increase of0.4% month-over-month, a bit less than expected, while July GDP was revised to show a slight decline from the previously reported slight increase. For August, services activity rose 0.3%, only half as much as expected, while industrial output rose 0.8%. September GDP growth seems likely to be similarly subdued given recent energy disruptions, while a recent renewed rise in COVID cases also adds a complication to the outlook.

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