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Bank of England Delays an Interest Rate Rise, Again

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- Basic interest rate unchanged at 0.5%

- Inflation, growth forecasts lowered, Sterling heads lower in response

- Analysts scathing in assessment of Bank's failure to move interest rates

Bank of England inflation report

Bank of England Governor Mark Carney, Image (C) Bank of England

FX quotes:
Pound-to-Euro exchange rate: 1 GBP = 1.1354 EUR

Pound-to-Dollar exchange rate: 1 GBP = 1.3522 USD

The Bank of England's Monetary Policy Committee (MPC) voted 7-2 to keep interest rates unchanged at 0.5% in their May policy meeting while the Bank's Inflation Report shows in-house economists forecasting inflation to cool faster than previously expected. These downgrades are a signal to markets the Bank won't be raising interest rates as fast as previously expected with question marks now hanging over whether rates will rise in 2018 at all.

In line with the moves, Pound Sterling sold off across the board with the currency easily being the worst-performer of the day. However, ahead of the weekend the Pound is maintaining a 0.4% weekly gain against the Euro, and is just 0.11% lower againt the Dollar, suggesting the event did not deliver the significant hit to Sterling many had feared.

Indeed, according to the Minutes from the policy meeting, MPC members see few implications for the economic outlook from the soft run of data that has characterised the start of 2018; a stance that appears to a number of economists to be at odds with the decision to keep rates unchanged.

"It's worrying when Bank of England’s decisions are not consistent with its analysis. Absent bad weather, the Bank’s Inflation Report suggests little has changed since their February assessment. Yet any prospect of a rate rise now appears to be disappearing rapidly over the horizon," says Andrew Sentance, an economist with PwC, and former member of the MPC who has been highly critical of the Bank's insistence of running emergency-low interest rates amidst an extended period of economic expansion.

Market pricing shows investors are still more-or-less pricing the prospect of an interest rate taking place in 2018 and there are a good portion of economists who agree, saying that the much-anticipated May rate rise has merely been delayed until later in the year.

"The accompanying comments and the fact that two members of the MPC – Ian McCafferty and Michael Saunders – continued to advocate for an immediate hike, suggests that the prospect of a hike this year is more finely balanced than current market pricing would suggest," says Nikesh Sawjani, UK Economist with Lloyds Bank Commercial Banking.

"In our base case, assuming that economic activity bounces back in the second quarter and CPI inflation proves stickier over the coming months than it did in Q1, we expect the Bank of England to deliver a quarter-point increase in interest rates at the August meeting," adds Sawjani.

Markets are currently placing a 50% chance of the August rate rise taking place.

Sterling had been rising ahead of the event with markets apparently favouring a positive outcome, we therefore warned the market was in danger of seeing a "buy the rumour, sell the fact" type reaction.

This appears to have been indeed the case, reinforcing the view that the currency has in fact only ever risen on three Bank of England super-Thursday events.

Pound's reaction vs. the Euro

"The MPC still sounds committed to a tightening cycle; key conclusions unchanged from March. Note that its lower CPI inflation forecast is based on a path for Bank Rate that is higher than in February and higher than markets now expect. In that context, further fall in Pound Sterling looks odd," says Samuel Tombs, UK Economist with Pantheon Macroeconomics.

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The Details: The Policy Decision

The key point to note from the minutes to the policy meeting relates to inflation:

"The MPC judges that the impact of the past depreciation of sterling on CPI inflation, while remaining significant, is likely to fade a little faster than previously thought. Taking external and domestic influences together, CPI inflation is projected to fall back slightly more quickly than in February, reaching the target in two years."

Meanwhile, the MPC's best collective judgement remains that, were the economy to develop broadly in line with the May Inflation Report projections, an ongoing tightening of monetary policy over the forecast period (i.e. ris in interest rates) would be appropriate to return inflation sustainably to its target at a conventional horizon.

"As previously, however, that judgement relies on the economic data evolving broadly in line with the Committee’s projections. For the majority of members, an increase in Bank Rate was not required at this meeting. All members agree that any future increases in Bank Rate are likely to be at a gradual pace and to a limited extent," say the Bank.

The Details: The Inflation Report

Below are the new forecasts, compared against the previous set of forecasts detailed in the February Inflation Report, note the inflation projections and the growth downgrade for 2018:

BoE inflation report projections

The Details: The Press Conference

We find striking Carney's view that business and households - in his view - expect "interest-rates are likely to go up at some time in the next year".

A 2018 rate rise is therefore still possible.

Indeed, he notes economic momentum in the economy is still there.

Ben Broadbent makes an interesting intervention during one of Carney's answers to a journalist that he observes money markets pricing an 85% chance of a rate rise by November.

Carney came under significant pressure from journalists who repeatedly questioned him on whether or not the Bank's guidance can be trusted owing to the sizeable about-turn in expectations for an interest rate rise to be delivered today.

Carney's response was that he caters not to financial markets, but to households and businesses who are still expecting an interest rate in coming months.

Yet, some economists have been quick to counter that financial markets and the fortunes of businesses and consumers are intricately linked.

Analyst Reactions: Deeply Divided

Lee McDarby, Managing Director, Corporate Foreign Exchange and International Payments at Moneycorp says he is seeing real money clients buying the dips in Sterling, and as such the Pound might find itself supported:

"After all the worries, and Sterling hitting a four month low, the fears of a hard sell-off of Sterling turned out to be unfounded. Across the thousands of businesses and private individuals that we support, we have seen an increase in activity from exporters keen to take advantage of the relative lows and we expect this to be maintained."

But Neil Jones, a foreign exchange dealer with Mizuho Bank Ltd. is less generous on his assesment of Sterling's outlook, noting Carney's admission that the UK outlook is clouded by brexit uncertainties. "Not a surprise to see a hike for 2018 being priced in. Frankly the BoE may wait until March 2019, its only a stone throw from Brexit Day. Sterling should continue to trend lower on this basis.

Andrew Sentance, an economist with PwC and a former member of the MPC is scathing in his assessment of the decision:

"Another poor decision by the MPC, keeping interest rates at 0.5pc despite nine years of economic recovery, a buoyant global economy, above target inflation and the lowest unemployment rate for 43 years. A failure of monetary policy strategy and leadership."

Clearly, he believes the risks associated with unnaturally low interest rates are growing and the Bank will have little in its armoury shold another recession strike.

"Monetary policy uncertainty and persistent low interest rates are having a negative impact on growth, not least by undermining sterling which squeezes consumers through higher inflation," adds Sentance.

Shaun Richards, an independent economist with a long history in City finance, is also critical:

"Mark Carney and the Bank of England would "really, really, really, really" like to raise interest-rates but somehow over the past 4 years they have not been able to find the right time. Is it June 2019 yet?"

But, David Lamb, head of dealing at FEXCO Corporate Payments says the call is the right one:

“Given the increasingly parlous state of Britain’s economy, the Bank’s tacit mandate will now trump its overt one. ‘Thou shalt not imperil economic growth’ suddenly seems much more important than worrying about reining in inflation.

“With the UK construction industry – long seen as a bellwether for investor confidence – now shrinking at its fastest rate for eight years, Britain’s economic prospects are weakening steadily. In this context a rate rise would be dogmatic at best, reckless at worst. And unless the coming months see a sudden improvement, the chances of a rate rise this year will only get slimmer."

But, Samuel Tombs, Chief U.K. Economist at Pantheon Macroeconomics reckons chances of an August interest rate rise have in fact nudged higher:

"The Committee wisely has refused to clearly signal the exact timing of the next rate rise. We continue to think that the odds of the August rate rise are slightly above 50%, given that the recent rebound in energy prices means that the latest inflation print probably will be higher before the MPC’s August meeting than at present.

"But the Committee will be sensitive to the activity data too, and given that business surveys so far suggest the risks to its new GDP forecast lie to the downside, the next rate rise easily could slip back to November."

James Smith, an economist with ING reckons there remain "a myriad of risks that could stop the BoE hiking this year, but based purely on what they've said today, it still looks like they'd like to squeeze in a hike this year if they can. Markets may have got a little ahead of themselves."

Smith's colleague at ING, FX strategist Viraj Patel, reckons based on all he has seen, Sterling remains cheap and weakness is likely to remain temporary: "one would think Governor Carney will keep all options on the table and certainly not rule out a 2018 hike. Fade this GBP knee-jerk move lower."

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