Bank of England

Thursday, March 29, 2018 - 02:30

MNI ANALYSIS: Downside Infla Risks Cloud BOE Rate Rise Message

By David Robinson

LONDON (MNI) - Bank of England Monetary Policy Committee member Gertjan Vlieghe in a March 23 speech suggested that Bank Rate may end up rising faster than markets were expecting. But that message will be tricky to convey if the MPC ends up showing inflation returning to around target in its May Inflation Report.

The UK Office For Budget Responsibility (OBR) has cut its inflation forecast to show it falling to around the 2% target fairly rapidly and then staying around it, standing at just 1.8% in 2019. The MPC will update its forecasts in May, but with sterling and rate expectations higher since February, its projections could also be cut.

The Bank's February Inflation Report (IR) projections had headline CPI inflation holding above target throughout the three year forecast horizon, with the four quarter rate at 2.3% in 2019, 2.2% in 2020 and 2.1% in 2021.


The MPC policy statements and March vote, with two members backing a hike, have delivered the message loud and clear that Bank Rate is very likely to go up from 0.5% to 0.75% in May.

If that hike is delivered, the May IR will be scrutinised for clues on where Bank Rate is heading next, but if the central inflation projection is cut that will cloud things.

Vlieghe said that with a tight labour market driving up domestic inflationary pressure the central outlook was "consistent with one or two quarter point rate increases per year" over the three year forecast horizon.

Money markets based on SONIA are currently pricing in Bank Rate rising to 0.9% in the first quarter of 2019, 1.1% in the first quarter of 2020 and around 1.25% in the first quarter of 2021.

Vlieghe's comments, taken literally, suggest that Bank Rate could rise by 75 to 150 basis points, taking in up to a range of 1.25% to 2.0%, with only the very bottom of that range in line with current pricing.


Those market rate expectations are still around 0.1 percentage point higher along the curve than in the run up to the February Inflation Report, which is one of the reasons why the OBR came up with an inflation forecast below the Bank's.

Other reasons the OBR had a lower projection were a rise in sterling on its effective exchange rate index, a downward sloping oil futures curve which offsets the recent energy price rise through the forecast and slower growth in average earnings than the MPC has been assuming.

The OBR's view on earnings growth is that upward wage inflationary pressures from a tightening labour market will be partly offset by higher non-wage costs for employers. A rise in the National Living Wage, effectively a minimum wage and the roll-out of mandatary auto-enrolment corporate pensions could see employers seeking to keep a check on costs by restraining pay growth.

The BOE agents report published Wednesday contained a corporate pay pressure survey which found that overall, firms expected output price inflation to fall back in 2018.

With consumption growth easing and intense competition on the high street and online, the agents report highlighted the downward price pressures faced by the retail sector. At the same, the Bank's Decision Maker Panel survey found finance offices also expected price pressures to ease, but their view was on average that inflation would only slow to 2.5% over the year ahead.

What is increasingly clear is that businesses and economists are confident that UK inflation has peaked having reached 3.1% in November and is now on the down-path.

The OBR and MPC, while sharing expertise and techniques, can again come up with somewhat different assumptions over how fast inflation falls back to target. Nevertheless, a softer inflation profile in May from the MPC and Vlieghe's message that markets may be under-pricing the likelihood of rate hikes would prove tricky to square.

--MNI London Bureau; tel: +44 203-586-2223; email:
--MNI London Bureau; +44 203-586-2226; email:
--MNI London Bureau; tel: +44 203-586-2225; email:

[TOPICS: M$B$$$,M$E$$$,M$$BE$]

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