Four Bank of England scenarios for August
In a nutshell: BoE to hike but keep quiet on its next steps
Markets are more-or-less fully pricing in a rate hike at this meeting, and we don't expect the Bank of England to disappoint. The economy appears to have rebounded in the second quarter and we think we could see a unanimous 9-0 vote in favour of a rate rise on Thursday (although there is a risk that Deputy Governor Jon Cunliffe dissents).
However, we expect the Bank to keep its cards close to its chest on the timing of its next move. While we suspect policymakers would like to hike again in the not too distant future, Brexit uncertainty and talk of 'no deal' could make it very complicated to do so. Beyond the usual signal that more "gradual" and "limited" tightening is needed, we don't expect any stronger hints from the Bank this week.
1 The economy has rebounded
Back in May, the Bank of England said that it was confident the economy would rebound after a weak start to the year - and not only that, it expected the original 0.1% 1Q growth figure to be revised higher. It's fair to say markets weren't convinced. Rate hike odds slipped below 40% in the days after the May meeting.
But since then, the data has largely backed up the Bank of England's story. The sun has given the high street a much-needed boost, while the overall service sector has recovered strongly. We still think the cracks in the economy (particularly in retail) could re-emerge; consumers are still fairly pessimistic on the economic situation, while real incomes remain under pressure. But for now at least, the economic story is largely playing out as the Bank had hoped it would back in May.
Admittedly there is one exception: wage growth. This is a key part of the Bank's rate hike rationale and it has lost some momentum since the turn of the year. The 3M/3M annualised change in earnings, a good measure of the short-term trend, has slipped from 3.1% in November to 2.6% now - although we doubt this will cause too many sleepless nights for the committee at this stage. Policymakers still expect pay to rise more rapidly as skill shortages in the jobs market intensify.
With a few exceptions, data has generally rebounded in 2Q
2 We think a unanimous 9-0 vote is likely - risk is Jon Cunliffe dissents
When the BoE hiked in November, there was some clear disagreement on whether a rate rise made sense. But this time, it looks like the monetary policy committee (MPC) is more united. Governor Mark Carney said earlier this month that the economy has "bounced back" after "erratic weakness" in the first quarter. That was echoed by policymaker Dave Ramsden - one of two dissenters back in November - who said recently that the data flow is making him "more comfortable with the balance of risks" than he was before.
So having already had three members voting for a rate hike back in June, it looks like we'll get at least eight voting in favour this week. The big question is whether Deputy Governor Jon Cunliffe joins the pack. He has struck a more cautious tone recently, although we think it's 50:50 as to whether he actually chooses to vote against a hike again.
We narrowly think we'll get a unanimous 9-0 vote, but we wouldn't rule out a lone dissenter.
3 Expect the Bank to keep quiet on its next steps
After this week, markets are barely pricing in another rate hike before the end of 2019. In an ideal world, we suspect the Bank of England would like to hike earlier, and would therefore like to see investors anticipating more tightening (or in other words, engineer a steeper rate curve). But in reality, with Brexit noise ratcheting up, it's not clear when the Bank's next opportune moment to hike will come.
With Prime Minister Theresa May facing heavy pressure from Conservative MPs on both sides of the Brexit divide, it's highly uncertain whether she'll be able to get a deal passed by Parliament when the time comes. Talk of 'no deal' has been ramping up as a result, particularly as details of the government's 'hard Brexit' plans have emerged.
As we discussed in more detail last week, we still think the probability of the UK crashing out without a deal is low. Both sides are now focused on finding a workable solution for the Irish border, which will enable the overall withdrawal agreement to be concluded. While whatever arrangement for Ireland is likely to prove contentious in the UK Parliament, the alternatives if the deal is rejected (a second referendum, another election, or article 50 extension) are probably even more unpalatable for Brexiteer MPs.
So in the end, we expect a deal to pass, enabling the transition period to begin. But crucially, this could all come quite late in the day. The UK and EU are still targetting October's EU summit to reach a deal, but we suspect a delay until December's summit is more likely. Only then can ratification by EU member states - including the UK - begin.
In the meantime, 'no deal' talk is only likely to get louder and if that begins to hit consumer and business sentiment, it could get increasingly complicated for the Bank of England to hike rates again.
For that reason, we think it is unlikely that the Bank will offer any further rate hike clues this week - beyond the usual signal that "gradual" and "limited" tightening will be needed. We don't expect another rate rise before May next year, at the earliest.