Image source: Bank of England. Credit Laura Bell.
The selloff in sterling and interest rate markets after Thursday’s Bank of England policy meeting is evidence of reduced investor expectations for the number of further interest rate hikes due in the coming months.
But British economist Robert Wood of Bank of America says it remains a hawkish central bank and there is a risk markets will become too dovish.
“Cautiousness and uncertainty yes, but we believe the BoE continues to signal that a series of rate hikes will most likely be needed,” Wood said.
Money market prices – according to the OIS market – show that there are now 123 basis points of increases expected for 2022, down from the 134 points expected before the meeting.
That still puts the Bank Rate toward 2.0% by the end of the year, which if reached would slow economic activity, the bank said in a statement.
“The BoE forecast implicitly suggests that the BoE sees a neutral somewhere between 1% and 1.5%, which we believe explains some of the BoE’s cautiousness,” Wood said.
The BoE noted that inflation expectations have jumped and this will provide a compelling reason to raise interest rates further, but gradually.
Although they acknowledged that British consumer confidence had fallen sharply, Bank of America pointed out that they had in fact reached recession levels.
“The BoE does not, in our view, want to accidentally tip the economy into recession,” Wood said.
The BoE has said the surge in inflation – it now sees inflation peaking at 8% – will be enough to depress economic activity and cause inflation to fall over the medium term.
“Going forward, inflation is expected to come down significantly as energy prices stop rising and the squeeze in real incomes and demand puts significant downward pressure on domestically generated inflation,” it said. the Bank’s press release.
But Bank of America says there is a risk of getting too “dovish” when reading BoE messages.
In fact, Bank of America’s proprietary “BoE Mood Indicator,” which uses natural language processing to measure the hawkishness of BoE minutes, hit an all-time high (the most hawkish).
Above: BofA Bank of England mood indicator. “The most hawkish BoE ever on our proprietary mood gauge” – BofA. See footnote for further notes.
“BoE points to strong wage growth, tight labor market, stronger than expected GDP growth, inflation expectations at record high,” Wood said.
The Bank of England also said services price inflation had accelerated, although to a lesser extent than other components, with prices for basic services returning to their pre-Covid trend.
“Underlying nominal earnings growth is estimated to have remained above pre-pandemic rates and is expected to strengthen further in the year ahead,” he said, adding:
“Given the current tightness of the labor market, continued signs of strong domestic cost and price pressures, and the risk that these pressures will persist, the Committee judges that an increase in the Bank Rate of 0, 25 percentage point is warranted at this meeting.”
Prior to the March decision, the market was expecting another seven 25 basis point hikes by next February, which would take the Bank Rate to 2.25%.
Bank of America expects four more increases, in May, June, August and November, bringing the discount rate to 1.75%.
Explanation: Bank of America Bank of England mood indicator:
The average MPC vote raises QE to the equivalent of the Bank Rate. BoEMI is scaled from 0 to 1 and reflects the proportion of “hawkish” sentences in each post. The indicator identified as BoEMI is intended to be an indicative measurement only and may not be used for benchmarking purposes or as a performance measure for any financial instrument or contract, or otherwise relied upon by third parties for any other purpose, without prior written agreement. consent of BofA Global Research.
This economic indicator was not created to serve as a benchmark. This performance is back-tested and does not represent the actual performance of any account or fund. Backtested performance describes the theoretical (not actual) performance of a particular strategy over the stated time period. No representation is made that any actual portfolio is likely to have achieved similar returns to those shown here.