BoE: Market reaction to February policy meeting & press conference - Westpac

BoE left its policy unchanged yesterday, but with a clear hawkish bias as the MPC projected higher growth, inflation and rates and markets now expect a rate hike in May, explains Tim Riddell, Macro Strategist.

Key Quotes

“Market Impacts from BoE’s MPC minutes

The 9-0 decision to leave policy unchanged was as expected. The lack of dissent was no doubt due to another significant and more hawkish change in the tone of both the MPC’s minutes and the Inflation Report.”

“Raising the potential of an earlier and more frequent rate moves

• Markets are already suggesting that “May is in play” by lifting their pricing for a 25bps rate hike in May to over 70% and also following the BoE’s projections for rates to lift 3 times (from prior 2) to 1.25% into 2021.
• The key comment that markets picked up on was that rates would likely rise earlier and faster than previously anticipated. Although Carney qualified this in the Q&A session, and repeated that moves would still be “gradual and limited” markets were more focused upon the initial description of their potential rate path.
• Carney stated that, in a change from previous perceptions, the Bank is content to allow rates to rise within the Brexit negotiation period even though he stressed that difficult negotiations are undergoing and as they progress, so will the MPC’s profiles and projections.
• The Bank’s projections within the Inflation Report show a stronger growth path in the near term, predominantly due to firmer global growth, with inflation remaining firmer due to higher oil prices.”

“Market interpretation and reaction

• As noted, the Bank lifted its current year and 2019 growth forecasts mainly due to global growth being stronger and oil prices influencing inflation with Carney stating that inflation would remain high in 2018.
• FX and rates markets quickly responded to clearly more hawkish tone and their concern over inflation pressures being higher.  Even though the MPC (and market now) are only projecting 3 25bps hikes until 1Q 2021, the shift in bias is providing the markets with fuel as they focus especially given the Bank’s repeated mention of upside risks to their projections.
• Markets are now pricing in some 70% chance of a 25bps rate hike in May, from 50% pre-meeting and around 35% a month ago.”   

“Key Conclusions

• The MPC lifted their projections for growth, inflation and rates with distinct upside bias
• Though seen as sooner and more frequent, the rises are still only 75bps over 3 years
• Inflation in the near term could spike above 3%, is expected to remain well above 2.5% this year and only gradually slide towards, rather than to, their 2% target in their forecast period
• Wage growth is expected to rise, but remain around 2% per annum, despite unemployment being near and even below their equilibrium rate (lowered to 4.25% from 4.5%)
• Although the Bank refers to an easing of strains on households, this still means that real wage growth is projected to be negative
• Brexit concerns remain, but were not seen as restricting the Bank's potential to raise rates during negotiations
• The prime Brexit concern remains investment and this was highlighted within a special analysis “box” in the Inflation Report
• Despite Carney repeating that the path of rate rises would be “gradual and limited in extent”, markets are focusing upon the hawkish bias and that risks to the Bank's projections are seen to the upside.”