Second U.K. Super Thursday: Again Not All That Super; No Change In Our View

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Super Thursday number 2 was really not all that super in our view. In summary, the BoE communications yesterday were on the dovish side – but we believe that’s really due to heightened expectations more than anything – as there were few real surprises. In terms of strategy, we maintain our expectations for a first rate hike in Q2 2016 albeit with the risks firmly skewed to a later rather than earlier date for the first rate hike (although such timelines are likely reliant on the Fed hiking in December). We also maintain our view that this later hiking in rates means that the BoE will have to act to pick-up the pace of rate hikes from late 2017 (relative to current market pricing) as inflation/wage pressures grow.

Key Insights

  • For the first time, the BoE cited the downturn in the external (EM) economy as the biggest change since the August Inflation Report – and one which continues to pose downside risks. There was also a heightened awareness on the downside risks to inflation from Sterling strength. In that sense, the BoE call is sandwiched between the Fed rate hike and the downside presented by EM. And whilst the BoE is data dependent, this is now external rather than domestic data.
  • There was also a subtle change to the mandate of the BoE, with them hoping to get inflation to target “in around” rather than “within”  2 years. However whilst inflation will rise slower than expected in the next two years (and remaining below 1% until late 2016), it will pick up sharply in the 3rd year (hence the continued call that rate hikes will have come to come faster from late 2017).
  • Finally, we also received additional information about the process for disposing of QE proceeds. Whereas the previous guidance was rather vague and referred only to when rate hikes were fully progressed, we were told today that APF sales would not occur until base rate was at least 2%.

Forecast changes

  • As expected, growth has been revised down in 2015/2016, before picking up again in 2017. This pick up from mid-2016 is as looser credit conditions boost investment and the housing market. 2.5% growth is assumed to be equal to the trend rate.
    Whilst there was an expectation that short term inflation would be revised downwards, the downwards revision have gone out further than had been anticipated – with the BoE citing sterling strength as the principle reason. However the pick-up in inflation in 2018 to surpass 2% provides rationale that the BoE will have to speed up the rate of base rate increases compared to current market pricing.
  • Labour market strength continues to surprise the BoE. Whilst they have downgraded their end 2015 wage growth forecast from 3% to 2.5% (as the remaining 0.5% slack in the economy is expected to be closed just a little later due to slower growth), wage growth still remains robust throughout the forecast horizon.

November Inflation Report

 

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