{"id":66746,"date":"2017-11-06T01:23:23","date_gmt":"2017-11-06T00:23:23","guid":{"rendered":"http:\/\/beta.next-finance.net\/opinion\/boe-to-proceed-very-cautiously-following-its-first-rate-hike-in-a-decade\/"},"modified":"2019-12-31T02:15:23","modified_gmt":"2019-12-31T01:15:23","slug":"boe-to-proceed-very-cautiously-following-its-first-rate-hike-in-a-decade","status":"publish","type":"post","link":"http:\/\/beta.next-finance.net\/en\/opinion\/boe-to-proceed-very-cautiously-following-its-first-rate-hike-in-a-decade\/","title":{"rendered":"BoE to proceed very cautiously following its first rate hike in a decade"},"content":{"rendered":"

The Bank of England (BoE) has delivered a much-anticipated 25bp rate
\nhike, tightening its monetary stance for the first time in over 10 years (or
\n3,773 days to be precise).<\/strong> The Monetary Policy Committee (MPC) 7-2 vote on
\nrates was at the hawkish end of market expectations. Moreover, the hike
\nwas not described as \u2018one and done\u2019, a strategy which could have backfired.
\nInstead, the BoE hinted at \u201cgradual and limited\u201d future rates hikes. <\/p>\n

However, the BoE removed a key sentence<\/strong> from previous statements, that monetary policy might need to be tightened \u201cby a somewhat greater extent than market expectations\u201d. This prompted a dovish market reaction, along with further comments on the \u201cconsiderable risks\u201d to the outlook<\/strong>. Despite marginally better economic news, the BoE downgraded its assessment of the supply-side once again. A key argument remains that weak productivity will translate into even lower potential growth, \u2018limited\u2019 economic slack and, ultimately, rising price pressure when full capacity is approached.
\nMeanwhile the BoE sees CPI inflation slightly above target, at 2.1% by end-
\n2020, based on the assumption of two further rate hikes over the next 3 years.<\/p>\n

We remain of the view that a Brexit transitional deal will be a necessary
\ncondition for the BoE to hike rates again (in May 2018, as per our baseline),
\nalthough it may not be a sufficient one.<\/quote>
\n In particular, wage growth needs to
\npick up to at least partially compensate for the loss in households\u2019 disposable
\nincome. Looking further ahead, the BoE would be in a position to normalise
\npolicy further only in the event of a soft Brexit maintaining the UK\u2019s access to
\nEU markets, in our opinion, hiking rates every 6 to 9 months, up to a terminal
\nrate which we estimate at around 1.5%.<\/p>\n

Chart 1: a first BoE rate hike in more than a decade<\/strong> <\/em>
\n\"chart_1-_a_first_boe_rate_hike_in_more_than_a_decade.jpg\"<\/a><\/p>\n

The UK political and macroeconomic outlook has not changed dramatically
\nsince we last updated our baseline scenario. Cyclical indicators were
\nmarginally stronger than expected in recent months, and real GDP growth
\ncame in 0.1pp above expectations, at 0.4% quarter-on-quarter (q-o-q) in Q3.
\nBut, if anything, forward-leading indicators continue to point to a moderate
\nslowdown in activity despite stronger global growth. In the end, the BoE
\nmade only small downward revisions to its growth forecasts, with GDP
\nexpanding by 1.6% in 2017-18, and by 1.7% in 2019-20.<\/p>\n

Households and enterprises still face the same headwinds capping spending,
\nincluding a large fall in real incomes and a close-to-record-low household
\nsavings ratio. A sustained increase in nominal wage growth would be needed
\nto boost disposable incomes and prevent the slowdown in GDP growth we
\nare forecasting in 2018, to 1.0% on average. That is what the BoE is expecting
\nvia a \u201csustained rise\u201d in wage growth based on labour market developments
\n(including a somewhat faster-than-expected reduction in slack as
\nunemployment fell to a 42-year low) and high vacancies.<\/p>\n

In the end, the revisions to CPI inflation forecasts were also modest. The 18%
\npast decline in sterling is still blamed for the bulk of the inflation overshoot,
\nand the BoE continues to forecast inflation to ease back toward its 2%
\ntarget over the forecast horizon, with the end-2020 point at 2.1%: \u201cwith little slack remaining and diminished growth in potential supply, modest demand growth is sufficient to restore domestic inflationary pressure\u201d.<\/em><\/p>\n

Chart 2: November 2017 BoE projections for CPI inflation and real GDP growth<\/strong> <\/em>
\n\"chart_2_-_november_2017_boe_projections_for_cpi_inflation_and_real_gdp_growth.jpg\"<\/a><\/p>\n

To be sure, a 25bp rate hike is unlikely to trigger a meaningful economic
\nslowdown,<\/strong> let alone a recession. The interest rate burden remains
\nmanageable, and the effect of higher rates could easily be offset by a small
\nrise in nominal wages. Ultimately, the medium-term outlook remains
\ndominated by the outcome of Brexit negotiations, hence a binary outcome.
\nWe stick with the view that a compromise will be reached at the December
\nEU Council on several key issues. Importantly, the focus seems to have
\nshifted to a more comprehensive settlement of financial liabilities, as well as
\nthe first contours of a post-Brexit trade framework. A December deal would
\nmove negotiations to the next stage and, ultimately, lay the ground for a
\ntransitional deal. The latter is a necessary condition for the BoE to continue
\nnormalising rates at a gradual pace, in our view, as we forecast a second
\n25bp hike in May 2018. Only in the event of a soft Brexit maintaining the
\nUK\u2019s access to EU markets would the BoE be in a position to tighten further.