Tilney Smith & Williamson on Bank of England interest rate decision

Sam Pham, Investment Strategist at Tilney Smith & Williamson comments on the Bank of England’s interest rate decision.

What happened?

The Bank of England voted unanimously to leave the Bank Rate unchanged at 0.10% at today’s policy meeting. Meanwhile, the Bank maintained the stock target purchases for corporate bond at £20bn in an unanimous vote and for gilts at £875bn in a 7:1 vote. A new set of economic forecasts were released. 2021 annual GDP is still expected to be 7.1% unchanged from previously, but 2021 headline CPI is now anticipated to be 4.0%, up from 2.5% expected in May.

What does it mean?
The split decision in the target for gilt purchases is in line with recent speeches that showed growing divergence between UK rate setters over appropriate policy stance. Sir Dave Ramsden, deputy governor for banking and markets, and Michael Saunders, an external MPC member, recently argued that the conditions for accommodative policy removal could be met earlier than expected. In the dovish camp, committee members Jan Vlieghe and Jonathan Haskel said that tightening policy at this juncture risks derailing the economic recovery in recent quarters.

At the heart of this debate lies inflation. Whilst UK harmonised CPI has risen above the BoE’s target of 2% for two successive months, this has been arguably driven by one-off factors due to economic reopening post Covid-19. For inflation to be persistently above target over the medium term, we agree with deputy governor Ben Broadbent that it hinges partly on the UK labour market, especially wages. UK average hourly earnings are increasing at a 8.6% year-on-year, data for May showed. This is the highest pace since record began in 2000, and we are watching this closely.

Overall, the Bank of England continues to be more hawkish against inflation than their Fed and ECB counterparts. The upgrade in CPI forecasts has further raised risks of policy tightening. The Overnight Index Swap market has traders pricing in a 60% chance of a rate hike in the next 12 months.

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