Initial thoughts on BOE IR

<p>The BOE kept rates and QE unchanged today, as expected. However, some BOE members are nearing their tolerance for CPI increases. Interestingly, although the BOE […]</p>

The BOE kept rates and QE unchanged today, as expected. However, some BOE members are nearing their tolerance for CPI increases. Interestingly, although the BOE raised their GDP forecasts, which was also expected by the market, they did not lift their CPI forecasts, which has sent sterling to fresh lows of the day.

We now wait to hear from Mark Carney, and the market will be trying to reconcile why forecasts haven’t been revised higher, even though price pressures are building.

The Inflation report states that price pressures are being kept in check by the 3% surge in sterling and the rise in UK bond yields in recent weeks. Thus, the Governor is looking for the FX market to do the heavy lifting for him, while the bank remains in neutral mode.

One thing that could spur the BOE to hike interest rates would be a significant pick up in wage growth, the IR states that ‘if pay growth picks up by more than anticipated, monetary policy may need to be tightened to a greater degree than the gently rising path implied by market yields’.

This small chunk of the 45 page report tells us something very important: watch wage growth like a hawk going forward. If pay packets continue to rise strongly then a rate rise will be on the cards. However, pay packets may not surge substantially until the labour market experiences a squeeze, which may not be until we leave the EU in 2 years’ time, or if immigration controls are tightened during the negotiation phase once the government triggers Article 50 next month.

Although the BOE did boost its growth forecast, this is more of a reflection of strength at the end of 2016 leading to greater economic momentum at the start of this year. The bank still sees many bumps in the road going forward, and the longer term GDP forecasts remain broadly unchanged.

The market is only concentrating on the inflation aspect of today’s report, and we will be watching the Carney press conference closely to see if the Governor shares concerns about rising prices, and at what level the majority of MPC members’ tolerance for CPI is breached. Right now, the market is giving back earlier gains, sterling and UK bond yields are lower. Any hawkish leanings from Mr Carney could send the pound surging again.

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