What to Expect from the BOE
The BOE meets on Thursday, where its broadly expected to hike rates by another 50bps, and signal that further hikes might be necessary. Here’s why, and how the market might react:
Economic data hasn’t been as bad as expected
The BOE and the UK Treasury both have already acknowledged the country is in a recession, although technically there haven’t been two consecutive quarters of negative growth so far. There has only been one quarter of negative growth, with the presumption that the current quarter will also be negative.
Since the last BOE meeting, data has been in line with the assessment of a recession, but not as bad as expected. This creates a complicated scenario for the BOE, because inflation is still in the double digits. In other words, stagflation, which can be much harder to recover from, because central banks and governments can’t do the standard things to break a country out of recession.
The potential scenarios
Typically, the negative economic growth of a recession leads to a reduction in inflation, often to the point of deflation. This gives central banks plenty of room to ease, and the government to spend. But the UK’s spending is already well beyond its means, with debt way too high. High inflation means the BOE can’t start easing. In fact, it might have to keep tightening, making the recession worse.
Eventually, one of the ways to finally get out of inflation is the so-called “inflate the inflation away”; that is, enough value destruction of the currency that people simply can’t spend. The practical impact is a long-term recession, something that pretty much everyone wants to avoid.
The great split
While there is considerable agreement on where to get to, there is considerable disagreement on how. Some MPC members are inclined to support the economy and let inflation run hot for a little longer. Others want to cut inflation off now, even if that implies a worse recession in the short term. As a result, a wide range of votes are expected.
It could be possible to have a four-way vote split, with votes for unchanged, 25bps, 50bps and 75bps all on the table. Though the consensus is for 50bps to win out in the end, potentially with a minimum plurality, and not even a majority. The market is pricing in a “double” hike, so anything different from that could shake up cable.
Divining the future
Counting where the “dissenting” votes end up could give some insight into where rates are expected to go. Currently the markets are pricing in 25bps for the next decision, and then rates flattening out.
But if there are more votes above 50bps than below, then it could signal there is bias in the MPC to keep hiking into next year despite the recession. But if there are more than three votes split up between unchanged and 25bps, it could mean that the BOE could end up with a softer terminal rate, and weaken the pound.