BOE Wakes up Hawkishly to Inflation

The Bank of England’s (BOE’s) monetary policy committee didn’t miss an opportunity to surprise with a triply hawkish move on Thursday. Not only did it lift the bank rate to 0.5 percent, as was widely expected, but four of the nine members voted for a double rate hike of 50 basis points (bps).

The pound rose initially against the euro but swung weaker after a more hawkish European Central Bank (ECB) meeting. Two-year gilt yields jumped 16 bps with a slightly smaller gain further out the curve. Sterling money markets are fully pricing in a 25 bps hike at both of the next two meetings, projecting official rates as high as 1.5 percent by yearend, triple their current level.

This was a game-changer of a meeting, with the BOE’s active reversal of monetary stimulus amounting to a tacit admission that it was left too long to curtail the secondary effects of rampant inflation seeping into the wider economy. The BOE now expects inflation to peak at 7.25 percent in April, with only a gradual return toward its 2 percent target by the end of its three-year horizon. Its forecasting skills have been called seriously into question with these repeated upward revisions.

The BOE is also expecting wage inflation to pick up this year, toward 4.75 percent, but also for unemployment to rise, surprisingly. That might be one possible handbrake on repeated rate increases.

Two outside members, Jonathan Haskel and Catherine Mann, have previously been viewed as doves. At the next meeting, on March 17, or perhaps at the May 5 monetary policy review, if one more member turns hawkish, there will be a third rate hike in quick succession. That now has to be viewed as a racing certainty, along with the bank rate hitting 1 percent by the summer, as there is no such thing as a dove anymore on the monetary policy committee (MPC). Even Silvana Tenreyro, who has never voted for a rate hike in any of her international central bank roles, voted for a hike this time.

That was only part of the hawkish conversion of the MPC. It was confirmed that the BOE’s 895 billion pound (US$1.2 trillion) balance sheet will be allowed to naturally shrink, as maturing holdings will not be reinvested. This has a pretty immediate impact, as a 28 billion pound gilt investment will now not be replaced. In total, more than 220 billion pounds over the next four years will mature, meaning a reduction of a quarter of the stock of the BOE’s quantitative-easing arsenal.

Even more aggressively, the BOE has called time on its 20 billion pound corporate-bond purchase scheme. It will be completely sold off over the next two years, with staggered auctions of its holdings. Sterling investment-grade credit spreads widened by between 5 bps and 10 bps in reaction. This is evidently a trial run for active gilt sales that the BOE reiterated it will consider when official rates rise to at least 1 percent. This is the big imponderable, which the MPC will take its time to consider and consult on widely, as it will effectively put it in competition with the U.K. Treasury’s debt management office, which handles the government’s debt raising.

The MPC may wish to see what the effect on financial conditions will be from its two-pronged stimulus reduction of raising rates while at the same time quantitatively tightening. But for now it seems content for the money markets to price in aggressive action. Times have changed, and slaying the inflation beast is top priority at last.

BOE Governor Andrew Bailey said markets should not extrapolate from today’s decision that rates are “on a long march upward,” but this was a somewhat limp effort to curtail higher rate speculation and was essentially ignored. Combined with the rise in the energy price cap from April, a measure that’s been softened slightly with 9 billion pounds of government subsidies, the cost of living in the U.K. has had a particularly painful day.

Copyright 2022 Bloomberg. All rights reserved. This material may not be published, broadcast, rewritten, or redistributed.