The latest inflation data are triggering a more forceful Bank of England response. We now expect potentially bigger and more hikes in the near term. While the outlook is more uncertain than ever, we think that the central bank is likely to raise rates at least until this autumn, with risks that it may need to do more.
- Self-sustaining inflation: The 50 basis-point increase versus the expected increase of 25 basis-points follows a reacceleration in core inflation (which excludes more volatile products such as energy and food). The latest report showed broad-based price pressures and other data pointing to robust wage growth and a tight labour market, with Brexit-related shortages perhaps having tightened it further and more structurally. Not only was the latest inflation report worse than expected, but it also shows that strong inflation is leading to strong wage growth which in turn leads to strong inflation and so on, in a self-sustaining dynamic.
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Unlikely BoE pause in the near term: This casts doubts on the future path of UK monetary policy and pours cold water on the prospect of the Bank being able to pause its rate hiking cycle, as the Fed did earlier this month, to assess the impact on financial conditions and the real economy. Looking at the near-term rate path, we expect yet another rate increase at the next meeting, followed by an additional hike at the subsequent meeting. With another inflation and labour-market report before August, the size of the next hike remains uncertain. Importantly, the Bank’s monetary policy committee will lose its most dovish member, Silvana Tenreyro, in August, perhaps tilting the risks towards a bigger hike if jobs and price data surprise to the upside. Conversely, it looks as if producer price inflation (the change in prices that producers charge for goods and services) is slowing sharply, partly helped by a somewhat stronger currency, commodity weakness and easing supply constraints. Further down the line, this could help the Bank to at least envisage a pause in rates, though we don’t believe we’re there yet.
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Rising downside risks on housing, earnings, and the wider economy: This monetary tightening impulse, with potentially more to come vs current forecasts, further squeezes household incomes and corporate profitability, makes public and private debt sustainability more challenging, and puts downward pressure on the housing market. This increases recession risks and skews the economic and earnings growth trajectory to the downside. Yet we believe that the Bank has no choice other than engineering much tighter financing and broader financial conditions, along with extra economic and labour-market weakness, to curb what now looks like enduring inflation.
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Information correct as of 23 June 2023.
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