Terminal confusion on BOE rates :Mike Dolan
LONDON — In the hazy outlook for all major central banks next year, the Bank of England’s trajectory seems peculiarly uncertain as markets appear at loggerheads with BoE guidance and forecasters.
The Bank itself – announcing its most recent rate hike early last month – publicly pushed back against what it then saw as excessive market pricing for further UK rate rises next year.
And yet those same market prices have barely flinched since then – despite a brutal fiscal squeeze in the interim, a near 20% drop in crude oil prices and a near consensus among official forecasters the British economy is already in recession.
When the Bank delivered its biggest rate rise in more than 30 years to 3% on Nov. 3, markets were then pricing a peak “terminal rate” of some 4.75% next summer.
And as policymakers now prepare for another half point rise next week, that terminal rate – the one Governor Andrew Bailey so clearly objected to – is still only marginally lower at 4.60% next September.
What’s more, based on that sort of pricing and prevailing energy futures, the independent Office for Budget Responsibility’s model projects two solid years of outright UK consumer price deflation from the middle of 2024 onwards.
Even median peak rate forecasts for next year from Reuters polling are, at 4.25%, some 35 basis points below where markets still doggedly price it. Many major banks within that sample -including UK high-street clearer HSBC, Wells Fargo, Royal Bank of Canada and Julius Baer – still see the terminal rate as low as 3.75%, almost a full point below market pricing.
By contrast, the median forecast for a similar poll on the U.S. Federal Reserve is exactly where futures currently price the Fed’s terminal rate next year – 5.0%. At 3.0%, it’s slightly above market pricing for the European Central Bank.
So why has the Bank of England’s explicit pushback and the prevailing economic forecasting not had any impact?
Part of the problem is the Bank’s own policy making council may be split as many ways as private forecasts – pleading a lack of visibility on anything from geopolitics to energy prices, election politics to Brexit, or stickiness of domestic wages amid a winter of labor strikes.
‘A GENEROUS SPIN’?
Dovish BoE council members Silvana Tenreyro and Swati Dhingra both voted for smaller rate increases than the 75bp hike delivered last month and still feel recession changes the equation.
As recently as Nov. 11, Tenreyro reckoned enough was enough and the BoE should stop at 3.0% through next year to allow the lagged effects to kick in and then reduce them in 2024. “Too high a path for (the) Bank Rate therefore risks over-steering inflation below target in the medium term.”
While less explicit on the precise rate, Dhingra echoed all that in interview this weekend and dismissed wage-price spiral fears. “A wage-price spiral would mean wages should be above inflation.”
It’s likely Bailey and his chief economist Huw Pill will prevail next week with a half point hike. But many analysts think there could still be calls for 75bps from hawks Catherine Mann, Dave Ramsden and Jonathan Haskel and as much as a four-way split in voting from the monetary policy committee.
HSBC doubled down on its 3.75% peak rate forecast on Tuesday, however.
“A generous spin would celebrate the lack of groupthink and note that with such an uncertain outlook, a wide range of views is understandable and perhaps healthy,” wrote HSBC economists Elizabeth Martins and Simon Wells.
“But more critical observers might say it adds to questions about the BoE’s willingness and ability to act decisively to address the current inflation challenge.”
The flipside for many is that the sheer uncertainty sown by the botched mini-budget and bond market blowout in September has built in a greater uncertainty premium into UK markets – if not outright risk premium per se.
Any reversion of terminal rate pricing to consensus or below could see the pound wobble again. Implied volatility in sterling is almost half the peak of September, but remains historically higher at more than 10% and a full point above the euro/dollar equivalent.
What’s more, a driving force behind many dovish assumptions on rates is the depth of brewing UK recession. But that’s as clear as mud to date – with the gloom possibly overstated so far and UK economic surprise indices still at their most positive since April.
For think tanks such the National Institute of Economic and Social Research, the Bank simply won’t get inflation back to 2% without pushing rates as high as 4.75%.
Deutsche Bank are almost as hawkish – seeing the terminal rate as high as 4.5% due what they see as overly negative BoE forecasts on growth and inflation.
But it also sees the risks with that as the bank seems determined to protest the markets.
“There is a premium in place especially with inflation continuing to outstrip market and Bank expectations,” said Deutsche economist Sanjay Raja. “That said, we have been stressing downside risks to our terminal rate projection, given the constant dovish messaging from the MPC. So there’s something to watch here.”
The opinions expressed here are those of the author, a columnist for Reuters.
(by Mike Dolan, Twitter: @reutersMikeD; Editing by Sam Holmes)