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UK in Focus: Rates on hold but upside risks remain

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The Bank of England (BoE) kept the Bank Rate unchanged at 5.25% with three dissenters preferring a 25bps hike. With inflation set to move lower, our central case is for no further rate hikes, and the first cut in February 2025. But, despite weakening data and a gloomy set of growth forecasts, the door is still open to further tightening if needed

UK data review (Aug/Sep 2023)

  • GDP rose in line with consensus in August at 0.2% m-o-m, following a 0.6% fall in July. Industrial production (-0.7%) and construction (-0.5%) growth both missed consensus but were offset by a slightly stronger services sector, where output rose 0.4% m-o-m. GDP was 2.1% above pre-pandemic levels in August, but has grown just 0.4% over the past twelve months. We think Q3 GDP is on track to be flat, with risks of a small negative print.
  • Total wage growth was 8.1% higher than a year earlier in the three months to August, slowing from 8.5% in the quarter to July, while regular pay fell to 7.8% from 7.9%. For the private sector, which the Bank of England pays particular attention to, total pay growth dropped to 7.1%, from 7.7% and regular pay growth slowed marginally to 8.0% from 8.1%. In real terms, total and regular pay were up – the third consecutive rise after an 18-month stretch of falls.
  • Headline unemployment was unchanged at a downwardly revised 4.2% in the three months to August, versus a low of 3.5% in August 2022. While HSBC and consensus had expected a rate of 4.3%, there was considerable uncertainty around this release, which was delayed by a week, due to methodological revisions. As we await a ‘transformed’ Labour Force Survey in the Spring, all we can really conclude from this new experimental series is that the unemployment picture did not change notably in July or August.
  • CPI inflation held steady at 6.7% y-o-y in September, slightly above consensus expectations for a decline to 6.6%. The stronger-than-expected print relates to core CPI inflation, which only edged down to 6.1% y-o-y, from 6.2% in August, above consensus expectations of 6.0%. This was driven by sticky services inflation (particularly from hotels, recreation and education services) which currently stands at 6.9% y-o-y.
  • PMIs for October were little changed, generally pointing to weak growth, falling employment and lower confidence. The service sector print inched up to 49.5 from 49.3 while the manufacturing print also ticked higher, to 44.8 from 44.3. The service sector business confidence index, however, fell to its lowest since December 2022 on subdued consumer confidence and weak client real estate demand.

Rates on hold but upside risks remain

The Bank of England kept rates on hold at 5.25%

The Bank of England (BoE)’s Monetary Policy Committee (MPC) voted on 2 November to keep Bank Rate on hold at 5.25% (in line with HSBC and consensus estimates). According to the minutes, “the decision whether to increase or to maintain Bank Rate at this meeting was again finely balanced”. However, for the majority, falling inflation was enough to warrant a pause, albeit “a further rise in Bank Rate remained a possibility”.

We don’t expect rate cuts until Q1 2025

The market appears to have taken this decision as a “hawkish hold” with the majority of the committee remaining concerned about the persistence of wage growth-driven inflation. Broadly, this is what we expected to see: a hold, with the door still open to the possibility of further hikes, and no near-term prospect of rate cuts. We don’t expect the BoE to lower rates until Q1 2025, while the market is pricing easing to come sooner, around Q3 2024 (chart 1).

Unchanged guidance = continued hawkish bias

The MPC kept their previous guidance, namely that: “monetary policy would need to be sufficiently restrictive for sufficiently long to return inflation to the 2% target sustainably in the medium term […]. Further tightening in monetary policy would be required if there was evidence of more persistent inflationary pressures”. At the press conference, Governor Andrew Bailey said that inflation is still too high and it’s much too early to be thinking about rate cuts.

New forecasts: a worse growth-inflation trade-off

Weaker growth on higher household savings…

On the new MPC forecasts, the biggest surprise to us was on growth, where the outlook is significantly more bearish than we had anticipated. Despite a somewhat more dovish path for interest rates, on which the forecast is based, the 2024 GDP growth forecast was trimmed from 0.25% to zero. This reflects a judgement that there will be a greater degree of household precautionary saving than previously assumed, partly on higher-than-expected unemployment.

…but energy costs and wages push inflation up

But despite the weaker growth outlook, the MPC has nudged up its ‘mean’ inflation forecast from 2.0% to 2.2% y-o-y in Q4 2024. The first reason for this is largely ‘mechanical’ in that it reflects higher energy (mostly oil) and ‘other imported inflation’ components, while the second relates to the labour market, where the MPC revised up its wages forecasts on the back of tighter-than-expected labour market conditions.

Conditions for a cut

The BoE needs to signal it believes its own forecasts

In order to see a realistic prospect of a rate cut, we need to see not only that the BoE is forecasting below target inflation, but also that it has started to believe its own forecasts. That might be conveyed by guidance in the statements or by the commentary surrounding the forecasts. To some degree, of course, growth weakness and higher unemployment will lead to expectations of rate cuts, but of course, these can coexist with excessive inflation, which puts the BoE in a less straightforward position.


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