Talk like a hawk, walk like a dove

Despite its much more hawkish rhetoric over the past month, and contrary to market expectations, the Bank of England’s Monetary Policy Committee (MPC) voted 7-2 on Thursday to keep the base rate of interest at 0.1%. 

The committee also voted 6-3 to maintain its asset purchase target at £895bn. But the MPC’s minutes make it clear that rates will rise in December unless there is convincing evidence of a sharp rise in unemployment after the end of the furlough scheme in September. In any case, in our estimation the pricing in of a further four rate hikes by the market by the end of 2022 looks premature.  

Why the delay? 

There seem to be two main reasons the MPC held off on rising rates today, despite forecasting that inflation was likely to peak at almost 5.0% in the second quarter of 2022 due to the surge in energy costs. 

First, the majority of the committee thinks there is a lot of value in waiting to see how the end of the furlough scheme has affected the labour market. That will be clearer by the next MPC meeting on 16 December, so a small delay seems sensible. 

Second, the MPC appears to have growing concerns about the outlook for economic growth. It revised its forecast for GDP down to around 1.5% in the third quarter of 2021, and to 1% in this quarter – that’s around half of the rates envisaged in the August Report.

It now sees GDP reaching its pre-pandemic peak in Q1 2022, three months later than it predicted back in August. Although the committee acknowledged that temporary supply issues have been holding back growth, it also noted that ‘at least part of the downgrade in near-term UK GDP prospects since the August Report was likely to have reflected a moderation in demand’. 

The committee flagged that further downside surprises to GDP growth could prompt a longer delay before it acts. Although, and its forecasts for growth over the rest of this year look sensible so we aren’t expecting any more downside surprises.

Lift-off rescheduled for December

Assuming that there isn’t a surge in unemployment in October, the MPC’s new guidance is that ‘it would be necessary over coming months to increase Bank Rate in order to return CPI inflation sustainably to the 2% target.’ This is about as a clear a signal as we can get that the MPC will hike interest rates in December unless the next batch of labour market data is really dire, and that’s unlikely. The latest data suggests that 87% of those who were on furlough when the scheme ended on 30 September have returned to work.

But the MPC took the opportunity to push back on the degree of rate hikes priced into the market. Its latest forecasts indicated that if rates rose in line with market expectations, i.e. to 1.0% in 2022, that inflation would fall below the MPC’s 2.0% target in 2024. It also said that if interest rates remained at 0.1% that inflation would still be above 2.5% in 2024. So, the key message from the MPC is that interest rates need to rise a bit, but not by as much as markets have priced in.

The RSM view

Overall, we expect the MPC to hike rates from 0.10% to 0.25% in December. That said, any further bad news on the economy or the labour market could push a rate hike back to February.

What’s more, next year we expect that interest rates will be closer to 0.5% than the 1.0% the financial markets are anticipating. This is not least because, once interest rates reach 0.5%, the Bank’s balance sheet will start shrinking as the Bank stops reinvesting the proceeds from maturing assets. This is a form of monetary policy tightening and the MPC will probably be wary of raising interest rates too quickly at the same time as it’s removing liquidity from the market.

Policymakers, market participants and firm managers should instead anticipate that global central bankers will talk like hawks to influence the yield curves and inflation expectations, and to act like doves by maintaining accommodative policies.

Over the next year, watch the central banks as much for what they do as for what they say.