BOE Downgraded Growth and Inflation Outlook. Market Bet for No Rate Hike This Year

Central banks news

BOE voted 7-2 to keep the Bank rate unchanged at 0.5% in May. The members voted unanimously to leave to asset purchase program unchanged at 435B pound. As we had mentioned in the preview, BOE’s message turned out more dovish than the market had anticipated. The staff revised lower GDP growth estimate for 2018 and inflation estimates over the forecasting horizon. As a result, the pound has dropped over 0.65% at one point against the euro and fluctuated around the 4-month low against US dollar. Although the central bank maintained the promise that interest rates would probably rise in the months ahead, the market has priced a no rate hike for the rest of the year after the announcement.

Acknowledging the weakness in the first quarter GDP growth, the central bank noted that it “had been consistent with a temporary soft patch, with few implications for … the outlook for the UK economy”. At the press conference, Governor Mark Carney reiterated the judgment that the softening is a temporary problem, due to the snowy and icy weather which hit Britain earlier this year. He added that he labor market has remained robust, with the unemployment rate at 4-decade low. Yet, the minutes indicated that “there was value in seeing how the data unfolded over the coming months, to discern whether the softness in Q1 might persist”, suggesting the majority of voters preferred to keep the powder dry until it is confirmed that the first quarter weakness was due to temporary factors, instead of a trend. The staff revised lower the GDP growth forecast to 1.4% for 2018, down from +1.8% prior. The forecasts for 2019 and 2020 were unchanged at 1.7%. Inflation forecast was revised lower to +2.4% for this year, compared with +2.7% projected in February. For 2019 and 2020, inflation would slow further to +2.1% and +2%, from February’s estimates of +2.2% and +2.1%, respectively.

Brexit remains the biggest uncertainty to UK’s economic outlook. The minutes suggested that, “although business investment is still restrained by Brexit-related uncertainties, it is being supported, like exports, by strong global demand and accommodative financial conditions. Household consumption growth remains subdued, in line with the modest growth in real income over the forecast period”.

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On the monetary policy outlook, the BOE largely left its stance unchanged. As the minutes suggested, “an ongoing tightening of monetary policy over the forecast period would be appropriate to return inflation sustainably to its target at a conventional horizon” if “the economy to develop broadly in line with the May Inflation Report projections”. It also affirmed that “all members agree that any future increases in Bank Rate are likely to be at a gradual pace and to a limited extent”. The market is now priced in no rate hike for the rest of the year. Indeed, the market has been losing confidence over communication of the BOE with Carney’s nickname of “unreliable boyfriend” returned. Carney has a track record of saying one thing and doing another since when he was the governor of Bank of Canada. Back in 2011, he had warned that monetary stimulus would be withdrawn. However, it was never realized by the time he left office in mid-2013.

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