No hike this month but an August rate rise looks likely
It's been a bit of a rollercoaster ride for UK rate hike expectations over the past couple of months. But in the end, we think the Bank of England will err on the side of caution and keep rates unchanged when it meets on Thursday. After all, a rate hike now could be one headwind too many for the faltering consumer-facing sectors.
But assuming the situation in retail doesn't get any worse between now and August, we think a rate hike over the summer still looks likely. With wage growth continuing to accelerate and global growth still (largely) heading in the right direction, we think policymakers are unlikely to have changed their minds when it comes to the prospect of further tightening. The Bank will also be conscious that Brexit noise could make it complicated to hike rates later in the autumn.
Markets are currently pricing a 50:50 chance of an August move, and there is a possibility that the Bank tries to subtly boost expectations. While we doubt we'll see any direct comments about the curve being too low this time, watch out for what the Bank has to say on growth, Brexit and wages, for signs that it is gearing up for further tightening in the months ahead.
Here's what we expect from the May meeting.
Four Bank of England scenarios for the May meeting
Cracks appearing in consumer-facing sectors give reason for pause
As the Bank of England prepares to meet next week, it'll be well aware that hiking in the aftermath of the weakest quarterly growth reading since 2012 would be a tough sell. Admittedly some of the causes of the slowdown were temporary – multiple bouts of snow saw construction activity make an unusually large negative contribution to first quarter GDP. It’s possible some of this gets revised up – and it’ll be interesting to see if the Bank agrees on Thursday.
But the cracks appearing in consumer-facing sectors look more concerning. The perfect storm of weaker demand, higher business rates and rising minimum wage costs resulted in one of the worst quarters for retail since the financial crisis. A rate hike now might prove to be one headwind too many for retailers, many of whom have become highly leveraged in the post-crisis years. And things aren’t set to get much better immediately - real incomes remain pressured by higher fuel and food costs (albeit the worst of the household squeeze has passed).
Alarmingly, consumer credit growth appears to have collapsed in recent months, with banks reportedly scaling back loan availability significantly. This may prove to be a blip, but we suspect the Bank will want to buy time until the underlying drivers of this rapid downfall become clearer.
Unlikely the Bank’s pause this month will turn into a permanent hiatus
Away from the activity story, the major drivers underpinning the Bank's recent tightening bias have remained largely on track. The prospects for global growth still look relatively bright, despite the recent moderation in Eurozone activity. Similarly, wage growth has continued to outperform over the last few months, giving policymakers greater confidence that skill shortages in the jobs market are boosting pay. Bank agents have indicated that this could be the best year for pay settlements since the crisis.
Policymakers will also be acutely aware that their window to hike rates could close soon. If the build-up to the December and March EU leader's meetings is any guide, the months leading up to the October summit could see negotiations get increasingly noisy. At the same time, we expect to see core inflation fall back to target over the summer, given that prices have now virtually adjusted to the new value of the pound. This has seen inflation fall noticeably faster than the Bank of England was forecasting back in February.
These two factors could complicate efforts to hike rates as we get later into the year, and we think the Bank will be keen to capitalise while they can. Assuming that the faltering consumer sector doesn't deteriorate further, we think there's still a good chance the Bank will hike again in August.