Bank of England’s Ultimate Move: Are They Secretly Parking the Bus?

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It’s a testament to the kind of 12 months the Bank of England has had that this is the second time we’ve used it recently”squeaky shit time” in a title.

When the Monetary Policy Committee makes its next rate decision on Sept. 21, it will mark almost exactly one year since the mini-Budget spawned one of our all-time favorite Wikipedia articles:

It’s fair to say that since then things have been moderately calmer, if not calmer altogether: a string of inflation overshoots has kept pressure on the MPC (while offering some relief on the currency side).

Now, after 14 straight hikes, the end may finally be in sight. As Governor Andrew Bailey told MPs yesterday:

There was a period where it seems to me that it was clear that rates needed to go up. . . and the question for us was how much and in what time frame, but I think we’re not at that stage anymore

I think we’re much closer to the top of the now [interest rate] cycle.

Markets appear to be tentatively in agreement: They were currently pricing in an approximately 80% probability of a 25 basis point hike based on Bloomberg’s WIRP estimates:

…which means it’s September and then it’s over.

The context of the data is interesting. Last Friday’s GDP data revision from the Office for National Statistics that changes the narrative everything has changed, and nothing.

The discussion in the Treasury Committee with the members of the MPC who complained of not knowing at the time that the GDP would be revised upwards was very amusing…

SHORT MEMORIES

It was higher at the time, it was revised down and then up again. They had the right data (sort of) at the time

— Chris Giles (@ChrisGiles_) September 6, 2023

Based on what we’ve seen on the sales side since then, there’s general satisfaction that growth and the strong job market are finally aligned, along with a repeated caveat: the (re)discovery of historic growth it simply means that the current outlook is even more meh.

As Konstantinos Venetis of TS Lombard says:

…the positive “level effect” of output does not translate into a proportionate increase in tax revenues and therefore does not make UK tax policies increasingly difficult the arithmetic is no simpler as the prospect of “higher(more) interest rates for a longer period” highlights the growing burden of public sector debt.

Nor does it alter what is a tightening cyclical picture: the economy is losing momentum and real GDP is set to stabilize this year as the lagged impact of this cycle of BoE hikes inevitably starts to be felt.

Recent PMI surveys have reinforced the feeling that the downtrend may finally be here:

It’s still pretty uncertain. Nomura’s economists, who are now talking about a recession in the Eurozone, see only a 40% chance that the UK will suffer the same fate. They write [our paragraph breaks]:

What could make the UK different? Overall, a number of factors indicate that the UK may be in a slightly better situation than the euro area:

(1) Perhaps most importantly, the BoE’s credit conditions survey shows much greater resilience for both firms and households to the UK’s monetary policy-tightening cycle, with demand for lending by businesses which has reportedly just been hit.

(2) Excess saving in the UK is higher, meaning households may have a stronger buffer to the impact of higher rates. However, it is true that these savings may be in the hands of higher income groups with a lower marginal propensity to consume.

(3) Regular private sector wage growth in the UK is much higher, potentially more supportive of consumption.

(4) The UK’s fiscal performance has recently turned out to be better than expected and the UK government has a more concrete fiscal easing plan ahead of the likely general election next year than the euro area where much uncertainty remains. on the timing of disbursement and use of NGEU loans.

(5) Despite recent upward revisions to UK GDP growth during the pandemic, the UK’s post-pandemic performance remains weaker than that of many competitor countries, suggesting that UK GDP has greater potential to make up ground.

(6) Finally, on a historical basis, the UK economy tends to grow at a faster pace than that of the euro area.

Offsetting these positives are the scale of the tightening that has occurred, higher inflation in the UK, the greater noticeable impact on the UK labor market from the tightening and, of course, Brexit.

Against this backdrop, the MPC’s next move appears delicately balanced. Self the pound is declining, which could sustain inflationary pressures longer than currently expected, but the pound could be . . . OK? Here is Rabobank’s Jane Foley:

While UK data is far from solid, it is now clear that the UK economy significantly outperformed prevailing forecasts last year.

A split is a certainty due to Swati Dhingra (whose annual report to the Treasury Select Committee, published yesterday, reads rather tragically). But Huw Pill and Ben Broadbent, both better bellwethersboth recently gave speeches in which they appeared relatively aggressive.

After all, there are reasons to be more positive about the UK’s economic outlook. Here is Berenberg’s Kallum Pickering in a note released today:

In stark contrast to the general mood of gloom hanging over the UK economy, businesses are ramping up capital spending at a rapid pace. Business investment had plummeted in the wake of the global financial crisis (GFC) and then stalled after the Brexit vote amid crippling political uncertainty. It then suffered another major blow during the COVID-19 pandemic. Weak capital investment hampers productivity, limits supply potential and helps push cost inflation.

But the situation is improving. As chart 1 shows, business investment is up 35% since its low in Q2 2020. In Q2 2023, it was 6% higher than its pre-Brexit high. While the recovery may not offset the costs of the post-2016 investment deficit, capital spending has now returned to its pre-global financial crisis trend. With any luck, the resumption of the old trend could be a sign that the UK’s growth potential is recovering after six years of deterioration.

Ironically, Pickering notes that one of the factors that could disrupt this positive trend is worries of a recession – in other words, that UK growth could be at a stage where “there is nothing to fear but fear itself.

It’s yet another unenviable position for Bailey and the gang, who could be vindicated by their decisions — or damned by them — in the months ahead.

Under the circumstances, we believe the MPC is very likely to do so park the bus this month: get defensive with the last 25 bps, then wait for this whole thing to resolve.

Further reading
— Some useless graphs on the BoE’s monetary policy committee