MPC meeting: Interest rates on hold, but energy shock puts a year-end hike in play
As expected, the Monetary Policy Committee (MPC) voted 6-3 to leave rates unchanged at 3.75% in September. That said, the guidance turned more hawkish as higher energy prices threatened to push inflation above 4% in the new year. With a more persistent shock looking likely and growth holding up despite the energy shock, the Committee looks increasingly uncomfortable keeping rates unchanged. Unless energy prices fall materially, a hike before year-end is now the most likely outcome
Hawkish hold, but Committee growing nervous
The MPC’s 6-3 vote to hold rates contained few surprises. The majority cited weak indirect pass-through from the energy shock and little evidence of second-round effects, reducing the risk that a temporary rise in energy costs becomes embedded in wages-bargaining and price-setting behaviours, which would keep inflation elevated for longer. The hawks countered that raising rates decisively now would put the Committee ahead of any second-round effects that, in Huw Pill’s words, are “costly to overcome” once entrenched.
More importantly, the minutes suggest that Clare Lombardelli and Governor Andrew Bailey, whom we see as the key swing voters, are moving closer to a hike. Both said that, unless energy prices fall sharply, the “case for raising Bank Rate is building the longer the conflict continues.”
For now, however, the Committee remains confident that limited second-round effects, soft labour market conditions and higher market interest rates will reduce inflation. The Bank can therefore wait until November or December to see whether energy prices retreat or clearer evidence of persistence emerges.
The Bank also reduced its annual quantitative-tightening pace from £70bn to £46bn and tilted sales towards shorter-dated bonds. That should ease pressure on long-term borrowing costs. Indeed, 30-year gilt yields fell by 10 basis points after the announcement.
All told, a hike today was always unlikely. But unless energy prices fall materially, the swing voters appear increasingly uncomfortable keeping rates on hold.
BoE likely to hike rates before year-end
Looking ahead, we now expect the Bank to raise rates before year-end unless there is a sharp and sustained fall in energy prices for three key reasons.
First, the Bank expects inflation to peak at over 4% and remain elevated for longer, relative to its July forecast. That matters because all the evidence suggests 4% is the point at which firms and households begin incorporating inflation more aggressively into wage and price-setting decisions.
Second, stronger growth forced the Bank to acknowledge “the possibility of a less stark trade-off between weak output and rising inflation.” Translating that from central banker speak, if demand continues to hold up in the face of higher energy prices – which will also make it easier for firms to pass on rising input costs to consumers – then the Bank will struggle to keep pointing towards subdued growth as a reason to keep rates on hold.
Third, and most importantly, the Bank’s guidance added that “given the lags with which second-round effects appeared, it was not appropriate to wait too long for evidence of such effects before responding with policy.” Until now, the absence of such effects has been a central argument against tightening. Therefore, the MPC has opened the door to a hike even if the data still show limited signs of inflation persistence.
Admittedly, there are still plenty of reasons to keep rates on hold. The labour market is weak, with pay growth already at target-consistent levels, indirect effects have been smaller than expected and even though growth has beaten expectations, the economy is hardly booming.
Ultimately, the outlook for rates will still hinge on energy prices. But with the Committee sounding increasingly uncomfortable with rates on hold as inflation is likely to reach 4%, our base case is now for a hike later this year and potentially another in February. That said, we do not expect Bank Rate to rise as far as the 4.75% currently priced in by financial markets.