The February Bank of England (BOE) Meeting Could Boost the Pound

The next meeting of the Bank of England (BOE) on February 2 could show a more optimistic consensus from the board, says Capital Economics’ Scott Bowman.

The latest readings have shown that GDP has held up better than the Bank forecast in November, whilst Unemployment is defying expectations it would rise above 5.0% (it is ‘stuck’ at 4.8%).

This will probably lead to the BOE upgrading its forecasts at its next meeting.

The recent strong rise in Sterling has also clipped the wings of inflation which is likely to rise more slowly than estimated.

Taken together with the economy’s resilience it will mean the BOE has more room to manoeuvre when it comes to setting monetary policy.

Instead of facing a stark trade-off between uncontrollably rising inflation and slow growth, it now faces “A less Challenging Trade Off,” in the words of

Capital’s Bowman, in which it may be able to raise interest rates without overly hurting employment.

This had been a major concern of rate-setters in the autumn reflected in the Deputy Governor Ben Broadbent’s comments that, ““We can tolerate high inflation because the alternative is a larger rise in unemployment, and weaker wage growth.”

The Hard Facts

The stats say things have now changed and there may be less need to “tolerate high inflation,” in order to prevent job losses.

Fourth quarter GDP has overshot BOE estimates of 0.4% in Q4, rising by 0.6% instead.

Average quarterly growth in consumer spending has rise higher than the BOE had expected, with Retail Sales showing a 1.3% rise in between August and November when growth in Real Consumption Spending had been forecast by the BOE to stagnate at 0.25% between Q4 and Q1 2017.

House Prices have also risen more strongly than the 0.5% expected, increasing by 1.3% instead.

The BOE have forecast Unemployment to rise above 5.0% in Q2 2017, but Capital’s Bowman reckons they will reduce that figure in the light recent data.

Average weekly Earnings were forecast to rise 2.25-2.75% in H1 2017, but they are already increasing at a quicker 2.8% clip.

Labour Productivity is rising faster than the moribund 0.25-0.50% rate suggested by the BOE in the autumn, as data has shown people working 0.1% less hours for more – 0.6% - growth.

CPI is still rising faster than the BOE’s 1.4% forecast in December, after increasing by 1.6%.

Sterling’s trade-weighted index has shown a stronger currency than forecast after rising 76.5, which is 2.5 points above the 74 forecast.

The overall strong data including the faster rise in inflation increases the chances the BOE will change its stance and consider raising interest rates.

This would be a big change from the current neutral -to-dovish stance.

Any hint of this 180-degree U-turn at the February meeting is likely to send Sterling flying higher.

The market is already adjusting to the new reality.

The actual chances of a hike materialising in February are still low at little over 1.0% but they are nearly double what they were a week ago as the chart below shows.

“Market pricing implies that the MPC may soon begin tightening monetary policy too. Indeed, Bank Rate expectations have risen significantly since the November Inflation Report,” said Bowman.

Bowman hastens to add that in the near term there is unlikely to be a rate hike but that the medium-term outlook has changed, mainly because of the stronger outlook for Sterling, which is expected to provide a headwind to rising inflation.

“However, stronger growth forecasts wouldn’t mean that a rate hike is imminent. We think the MPC will lower its overall inflation forecasts as the effect of the rise in sterling outweighs the upgraded growth forecasts,” said the economist.”

Due to the elevated Pound, inflation is not expected to overshoot the BOE’s 2.0% target by as much as previously expected.

Sterling is 5.0% higher than expected in the autumn inflation report, due to the possibility of a softer Brexit.

“The rise in sterling could knock a few tenths of a percentage point off the MPC’s forecasts for inflation in its February Inflation Report, all else equal,” said Bowman.

Given GDP growth is likely to remain buoyant because of the relatively till weak pound, Capital anticipate a possible rate hike in 2018.

“We have pencilled in an initial rate hike for Q4 2018, which would just be a reversal of the emergency cut made in after the Brexit vote,” said Bowman.

.