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Writer's pictureRosbel Durán

🏦ING: Bank of England Meeting Preview

Expect upward revisions on MPC's forecasts

  • Reopening-related price spikes in various consumer services are combining with lingering supply chain disruption and energy base effects to drive a faster inflation rate than the Bank had pencilled in back in May. We now expect CPI to peak around 3.5% later this year, compared to 2.5% as the Bank was forecasting back in May

  • The BoE had previously pencilled in a peak of 5.8% - around a one percentage point spike. The recent run of jobs data has certainly been fairly solid, though we’d caution that the number of people on the furlough scheme has not fallen as quickly as the wider recovery might have implied. That suggests a spike in redundancies is still likely in the autumn

  • We also don’t expect any wholesale changes to the medium-term outlook for growth – and we’d expect the Bank to reiterate its forecast that the size of the economy will reach pre-virus levels in the fourth quarter

Don't expect hints on rate hikes

  • Firstly – and most obviously – the Delta variant has clouded the near-term outlook. We’d expect the Bank to pare back its forecast for third quarter growth from 3.8% to something more like 1.5-2%. Ultimately this is (hopefully) going to be a temporary story, but the short-term disruption has effectively pressed pause on the recovery and may have tempered some of the consumer optimism that had emerged through the spring. If nothing else, it’s a reminder that the recovery is unlikely to be smooth.

  • Secondly, while markets have scaled back rate hike expectations in the longer term, the bit that’s most relevant for the Bank of England is what’s priced in two-three years time. And on that score, investors are still pricing in a modest amount of tightening.

  • Finally, the medium-term inflation story looks much the same as it did before. Despite recent staff shortages, we aren't convinced we're about to enter a period of above-target wage growth. And that suggests the BoE's inflation forecast for two to three years' time is likely to be roughly at target - and it's this that is ultimately relevant for policymaking today, rather than what will happen over the next six to twelve months.

No early QE end, perhaps balance sheet reduction

  • The more interesting question perhaps is whether we hear anything new on the topic of balance sheet reduction – or reverse QE/quantitative tightening as it’s otherwise known. This is uncharted territory for the Bank, which unlike the Fed, did not shrink its pool of government bond holdings in the post-financial crisis years

  • That’s mainly because Bank rate never came close to 1.5%, which was the threshold the BoE has long signalled to be when balance sheet reduction could occur. But under Governor Andrew Bailey, a future tightening cycle is likely to be accompanied by some reduction in the amount of gilts the BoE holds. The motivation is to provide more space to be ‘bold’ in a future round of QE.

  • One ‘passive’ approach to this could see the Bank of England allow maturing bonds to roll off the balance sheet without reinvesting – perhaps by setting an annual target.

GBP rates are highly skeptical

  • Following the June Fed meeting, yield curves globally went on to price in a dismal outlook for the economy, an outcome supposedly precipitated by the Fed’s new found hawkishness. We think this narrative has its limitations but the mindset prevailing in rates market is undeniably gloomy. This means sterling rates will not take kindly to another barrage of hawk-talk from the BoE next week.

  • The chorus of hawkish comments has prevented sterling rates from participating in the subsequent stabilisation seen in other markets. This is visible in the continued flattening of the GBP 5s30s slope over the past weeks at a time the EUR and USD curves regained their composure. As it stands, we think the slope is already in policy error territory. As we think the BoE collectively will adopt a more cautious tone, the bar for some re-steepening is low.

  • A confirmation of the tentative decline in Covid-19 cases in the UK would cement Gilts’ underperformance relative to Bunds and Treasuries. It would also light a fire under the long-end. Remember that as BoE tightening looms, Bailey has flagged that balance sheet reduction could occur in parallel to rate hikes. This means a decompression of GBP rates is a real possibility over the coming months.


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