The markets are pricing in a 107% chance that the BOE will ease at the next meeting, as a sign of just how dovish expectations are for Thursday’s meeting. That means that as far as traders are concerned, the 25 bps cut is a done deal, and there is even a small (7%) chance that the BOE could go for a 50 bps move.
Of the major central banks that started their easing cycle last year, the BOE has been the slowest to cut rates. That’s because the UK also had the highest inflation which was taking a long time to come down. At the start of the year, markets expected that trend to continue. But the developments around the trade wars plus the constraints on government spending by the UK government have changed the situation. After the IMF cut (again) the UK’s growth outlook, the markets started to expect the BOE to finally step up the easing moves.
Why the Time Has Come
Inflation is intimately related to economic growth. When the economy accelerates, so do prices. And the same in reverse, which can be an additional problem for the central bank. If the economy slows down, then inflation can fall below the target and enter a deflationary period. Typically, deflation is seen in the midst of a recession, and can keep the economy from recovering. That’s one of the reasons why central banks are eager to prevent deflation and cut drastically during an economic downturn.
There is another wrinkle being added: The trade wars. While the conventional wisdom is that tariffs increase the cost of imported goods, it has a different effect on countries not participating in the tariff war. That is, so far, the UK, which hasn’t raised any of its tariffs. As importers lose markets due to tariffs in the US, they might look to offer better prices in the UK to reduce inventory. This is one of the mechanisms in which the trade war can be deflationary. BOE MPC member Megan Greene said that tariffs could be deflationary for the UK a couple of weeks ago, and this has ramped up expectations that the BOE will now move into an easing mode as inflation in the UK is expected to go down.
More Than a Quarter of a Point?
BOE officials have made other comments that lead to suspecting a larger rate move. MPC member Catherine Mann argued after the last meeting where she supported a 50bps cut that the bank needed to make bigger moves to communicate with the market more effectively. This implies that there could be at least two votes for a “double” rate cut on Thursday: Mann and the eternal dove, Swati Dhingra.
Investors will likely be keenly looking at the vote split to see if more MPC members vote for a bigger cut. The consensus is for there to be three more cuts after this upcoming meeting. Two of those are projected to happen in the subsequent three meetings. That means the market expects a “pause” for one meeting, but isn’t sure when it will happen.
The Market and the Pause
Traders are likely to react based on whether the vote split implies another rate cut or a pause at the next meeting. The pound has some room to gain if the BOE opts for the “hawkish” side. But the strong expectations for further easing implies that the market is likely expecting a signal for another rate cut. Which limits the surprise factor if the BOE opts to be more “dovish”.
Note that this time around, the BOE’s policy meeting will be delayed by two minutes due to the VE day observance.