BoE cuts near-term forecasts, points to hike towards turn of year

Policymakers at the Bank of England opted to keep Bank Rate on hold on Thursday, sticking to their forecasts for a moderate pace of economic expansion over the medium-term, while pointing to current market pricing for another hike in Bank Rate around the turn of the year - although there were two dissenters.

"There was value in seeing how the data unfolded over the coming months, to discern whether the softness in Q1 might persist, and to learn about the extent to which the economy was evolving in-line with the May Inflation Report projections," the MPC judged, according to the minutes of their meeting.

"At this meeting, the costs to waiting for additional information were likely to be modest, given the need for only limited tightening over the forecast period to return inflation sustainably to the target."

Dissent at the BoE

As expected, Ian McCafferty and Michael Saunders stood their ground, dissenting from the decision by their peers to stay put on policy.

Having put more weight on survey results and labour market data, they defended that it was appropriate to hike Bank Rate by 25 basis points now, judging recent weakness in GDP to be "temporary or erratic".

Few changes to forecasts for activity

The MPC on the other hand described the weak first quarter print on gross domestic product as a "temporary soft patch", likely reflecting the adverse weather seen over February and March.

They expected that weak GDP print to be revised higher, to around a 0.3% quarter-on-quarter pace, up from ONS's preliminary estimate of 0.1%, predicting that the pace of expansion was set to return to 0.4% clip over the second quarter.

In fact, aside from that weaker reading on GDP, rate-setters' central forecast for the economy was little changed from the last Inflation Report, with GDP seen growing by about 1.75% per year, on average, over the forecast horizon.

For 2018 however, GDP was now seen growing more slowly, by 1.4% instead of 1.8%.

Wage growth and domestic cost pressures continued to firm gradually and "broadly as expected", the MPC also said.

Likewise, at just 0.25 percentage points, the degree of 'slack' in the economy was still seen to be "very limited" and was expected to shift into a "small margin" of excess demand towards the start of 2020.

Meanwhile - and always conditional on a gently rising path for Bank Rate over the next three years - consumer price pressures were seen receding slightly "faster than previously anticipated".

"The prospect of excess demand over the forecast period has reduced the degree to which it is appropriate for the MPC to accommodate an extended period of inflation above the target," rate-setters said.

"As previously, however, that judgement relies on the economic data evolving broadly in-line with the Committee's projections."

Broadly similar underlying assumptions, outside of CPI

Among some of the tweaks made by the MPC to the assumptions underlying its forecasts, the market interest rate curve was marked a tad higher, with three 25 basis point rate increases now fully priced-in.

CPI was also now seen returning to target more quickly, falling to 2.4% over the course of 2018, instead of 2.7%, and then to 2.1% over the course of 2019.

Key to the near-term behaviour of consumer prices, policymakers revised down their estimates of by how much the weaker exchange rate fed through into import prices.

The MPC also marked down their forecast for the rate of growth in euro area GDP in 2018 from 2.75% to 2.5%, but kept that for the US steady at 3.0%.

UK unit labour costs on the other hand, were now seen growing more quickly this year, by 2.75% versus previous forecasts for an increase of 2.0%.

Anticipating that, in the meeting minutes the MPC noted how whole-economy average weekly earnings growth had accelerated from a 2% pace over the first half of 2017 to 2.8% over the first three months of 2018.

The MPC was also forecasting a stable Sterling exchange rate over the medium-term, alongside a slow fall in Brent crude oil prices from $71 a barrel in 2018 to $65 in 2019 and $61 in 2020.

Another underlying assumption was market pricing for the Fed funds rate, the US central bank's target interest rate, to be at around 2.5% towards the end of 2019.

For the first time ever, in the May Inflation Report the Bank of England also included a numerical estimate for the degree of slack that they saw in the economy.

MARKET UNCERTAINTY

Economists and analysts were divided as they tried to make sense of the Bank of England’s decision to keep rates on hold while trimming its economic forecast.

David Owen, chief European financial economist at the stockbroker Jefferies, said the BoE’s commentary suggested this year's rate rise had been delayed rather than abandoned.

“August BoE rate rise on the cards,” Owen wrote. “7-2 vote, but more significant is the BoE's belief that the UK grew at 0.3% in Q1, NOT 0.1%, so economy not as weak as some data suggests with very limited degree of slack.”

Barclays’ economists Fabrice Montagne and Sreekala Kochugovindan said the BoE's decision to cut the annual growth forecast was confusing because it treated first-quarter weakness as a trend rather than a blip. The MPC will put more onus on responding to indicators rather than sending signals to the market, they added.

They said: "While a confident BoE in normal times would likely have happily looked through a growth soft patch and hiked, increasing doubts regarding the outlook amid high levels of uncertainty led the MPC to forgo a rate hike in May and reshape the timing of its tightening cycle.

"We think the bar for a hike in August is now as high as 0.5% q/q growth in Q2 as well as uninterrupted improvements in the labour market. We believe that such a scenario will not materialise and that weakening underlying growth will deter the bank from hiking at all in 2018 and 2019."