The reasons why the BOE is set to raise the bank rate in November? - Natixis

"The Bank of England faces a conflict of objectives, as pointed out recently by the International Monetary Fund’s Chief Economist. There are compelling reasons for raising the bank rate on 2 November. There are also compelling reasons for maintaining the status quo," argue Natixis analysts.

Key quotes:

"One can imagine that, whatever decision is taken, the split will be tight between MPC members having voted for an immediate hike and those having voted to maintain the status quo."

"The main arguments for a 25bp hike in the bank rate are:

• Inflation: headline inflation now reaches 3%, its highest level since 2012, while at 2.7%, core inflation is also at its highest since 2012.
• Inflation expectations: these are trending upwards in the case of both households and firms, while the breakeven for the index-linked Gilt is on an uptrend since the start of August and now towers at 3.15%.
• Unemployment rate: in July it reached its lowest level since 1975. Employment and earnings data for September and August are due to be published this morning and, needless to say, will be scrutinised by the markets."

"Factors in favour of maintaining the status quo are:

• The shape of the Phillips curve: wage elasticity to changes in the unemployment rate is next to nil since the start of the 2010s, which explains the year-on-year erosion in real earnings.
• It is not wage growth that is stimulating inflation, but sterling’s exchange rate and exogenous factors, such as commodity prices, notably for agricultural commodities, which are volatile.
• Slowdown of the economy and downward revision of growth forecasts, notably by the International Monetary Fund (IMF): the UK, one of the best pupils in the OECD class last year, is now the one bringing the rear. Consumption, in particular, is suffering from the year-on-year erosion in real earnings, the sagging consumer confidence (which tracks the evolution in real earnings), the increase in the household saving rate, and the tighter lending conditions (largely at the urging of the Bank of England).
• And, especially, Brexit: negotiations concerning the new trade agreement between the UK and European Union (EU) and the transition period are unlikely to get under way before next year, in the best of cases. The first five negotiating rounds were supposed to have achieved sufficient progress on first-phase issues (Brexit bill, rights of EU27 citizens living in the UK and of UK citizens living in the EU27, and the border between the Republic of Ireland and Northern Ireland) but have failed to do so. In particular, an agreement over the Brexit bill seems a long way off, even though the UK has relented somewhat (notably since the famous Florence speech)."

"A hike in the Bank of England’s bank rate is transmitted fairly rapidly to the economy, given notably the structure of household debt (which is mainly at variable interest rates). By raising key policy rates, the Bank of England will therefore risk further penalising economic activity and, hence, introduce a monetary risk in addition to the existing Brexit risk. This may not prove judicious after the failure of the fifth negotiation round..."

"The Bank of England has sold the idea of an interest rate hike. For the market, there is an 80% probability of a hike on 2 November. The solution to overcome this conflict of objectives would be for this interest rate hike to be bundled with a message stating clearly that this move should not be interpreted as the start of a lengthy monetary tightening cycle, but rather as a one-off measure. By precaution, the Bank of England lowered the bank rate in the aftermath of the 23 June 2016 referendum. It can be argued that this precautionary measure can be withdrawn, as the doomsday scenarios voiced at the time have not materialised."