June BoE MPC Preview: Tentative steps towards a tightening?

By Jeremy Hawkins, Senior European Economist
June 22, 2021

Having for technical reasons reduced weekly QE purchases by £1 billion a week at the May meeting, financial markets expect little in the way of new policy initiatives in Thursday’s BoE MPC announcement. However, in the wake of a round of surprisingly strong inflation data, investors will be looking for any signs of a more hawkish tone from the Bank. Chief Economist Andy Haldane, for whom this will be the last MPC meeting, broke ranks last month by voting for a £50 billion reduction in the QE ceiling to £825 billion, a move that would have had significant policy implications. There may now be some other members who see the current stance as overly accommodative in the context of what looks likely to be a strong rebound in economic growth and rising inflation risks.

Still, the MPC went out of its way to stress that May’s tapering was simply a technical adjustment aimed at ensuring that the QE ceiling would not be reached ahead of schedule and, crucially, not a change in policy. The Bank sees the stock of QE, rather than the purchase rate, as the key metric for assessing its stance. As such, any significant shift is probably still some while off. Even so, the recent buoyancy of the economic data means that the already rapidly diminishing prospect of a move to a negative Bank Rate is now even more remote.

Inflation has hardly featured on the BoE’s radar since the arrival of Covid; the MPC focussing instead on supporting the real economy in general and the labour market in particular. However, last week’s surprisingly strong May CPI report could well change that. At 2.1 percent, the annual headline rate moved above its 2 percent target for the first time since July 2019. More significantly, the core rate jumped fully 0.7 percentage points, the third steepest increase on record, to 2.0 percent, its highest reading since August 2018. The Bank’s May Monetary Policy Report (MPR) anticipated a temporary pick-up in inflation but last month’s report must still have come as something of a shock. Moreover, the data were collected before the third phase of unlocking was introduced on 17 May, which probably makes for upside risk to June. In fact, pipeline pressures have been on the rise for some time. Hence, regular earnings growth jumped to a record high in the three months to April while factory gate inflation has already climbed nearly 5 percentage points since the end of last year. At the same time, house prices are rising at their fastest pace in almost seven years.

Upside risks to inflation have been boosted by signs of a rapid recovery in economic growth. After contracting in January, GDP expanded fully 5.2 percent through April. At the same time, even just a flat June would still see second quarter retail sales volumes up some 12.6 percent versus the first quarter. The rebound in both demand and supply has been reflected in the labour market where the ILO jobless rate is now at its lowest level since the third quarter of last year. Meanwhile, Brexit effects on trade with the EU remain negative but seem to have dwindled markedly since the start of the year.

Nonetheless, with the unemployment rate still 0.8 percentage points above its pre-pandemic level, the BoE remains very wary about how the jobs market will respond to the termination of the Coronavirus Job Retention Scheme (CJRS), currently still scheduled for the end of September. Such concerns will inevitably ensure a cautious approach to any change in policy.

In any event, since the May MPC meeting the domestic economy has continued to outperform market expectations – in fact, Econoday’s economic consensus divergence index (ECDI) has hardly been out of positive surprise territory since the middle of February. This increases the chances of second quarter growth coming in rather stronger than currently discounted.

That said, near-term recovery prospects have not been improved by the latest Coronavirus developments. The government had been hoping that the economy could be fully reopened on 21 June. However, the arrival of the highly transmissible Delta variant has led to a sharp rise in Covid cases and the date has now been moved out to at least 19 July. This will have a major impact on the likes of the hospitality sector and, in particular, the already devastated travel industry. Moreover, the effects here will be all the worse since the government is currently refusing to provide any additional financial support. As such, it may be that immediately ahead economic growth is a little disappointing.

Against this backdrop, Thursday’s announcement could reveal a slightly wider MPC split on QE as well as a somewhat less dovish tone to the official statement. Neither eventuality would imply any significant shift in policy in the near-term but financial markets might well interpret either as constituting the first tentative step towards an earlier, albeit probably still distant, hike in Bank Rate.