• Joel

Bank Of England; To Cut Or Not To Cut?

In the last two weeks, dovish commentary from MPC member Tenreyro, Vleighe and Governor Carney, combined with some shockingly bad GDP, retail sales, CPI and manufacturing sales data out for November and December saw market pricing for a BoE rate cut this month shoot from virtually nothing to above 70% at one point.

However, solid jobs and PMI data this week have seen that pricing pare back to a 50% chance of a 25bps cut. In other words, markets are split.

So let's examine the arguments for and against a cut…

Firstly, PMI data appears to have solidly rebounded in January. This is the most important factor for keeping rates on hold, as both Tenreyro and Vlieghe have indicated that they will likely vote for a cut unless surveys rebound (which they appear to have).

Secondly, the BoE meeting is scheduled the day before Brexit is finally set to take place on 31 January. Ever conscious of being seen as independent, the Bank may see this as a politically sensitive time for a rate cut.

Moreover, the fiscal budget statement will be announced in February. It is likely to be expansionary and could a further boost to the economy.

Additionally, as noted by Nordea, the BoE have a history of acting with patience in recent times. “Waiting would also follow the BoE’s reaction function post the Brexit referendum… the MPC did not rush into a rate cut at the July meeting following the referendum – even despite markets pricing it almost 100% - but waited until August.” They continue, “the same happened in May 2018 when markets priced >50% for a hike, however, the BoE waited until August as they could then get a bigger key data sample”.

Finally, the January meeting is Carney’s last before Andrew Bailey takes over in mid-March. Again, it would be an odd timing to cut and set the future direction when the new boss in town could see things differently. This is not standard practice among major central banks, although it is what we saw with the ECB (remember Draghi’s Bazooka anyone?!).

Now onto the arguments for cutting rates.

Not only have there been dovish MPC signals, but inflation has also softened somewhat. Moreover, it appears the BoE, in contrast to 2018 when inflation also undershot target, is not worried about a weaker sterling.

Moreover, as noted by analysts at Nordea, “with less easing ammo left, it could be wise to move swiftly and aggressively (at least according to Saunders).”

Perhaps the biggest argument for cutting rates now is the fact that Brexit is no longer tying the committee's hands. Yes, now may be an odd time to cut given Carney is leaving and it is a day before the official Brexit date, but from the public (and market’s) perspective, Brexit has been sorted since Boris won the election back in December. It is, therefore, more much less “political” to cut rates now compared to the second half of 2019.

With more clarity now, BoE’s hands are no longer tied to the same extent. If not for Brexit, we also think BoE would have both hiked and cut over the past 1.5 years. Then again, the economic development would not have been the same without Brexit, so enough with the tinfoil hat speculation. It’s time to announce a winner between “rate cut” and “on hold”.

All in all, most analysts I have spoken too think the BoE will hold this time around. And I agree.

The UK economy does appear to be enjoying a post-election rebound, which, coupled with an improvement in global economic conditions, reduces the BoE’s urgency to cut rates sooner rather than later. I do expect them, however, to essentially follow in the footsteps of the BoC and leave the door open for cuts down the line should the recovery falter.

Here are some quotes from some of the major banks:

Lloyds: “We believe the BoE will keep Bank Rate on hold at 0.75% on 30 January, albeit with the significant risk of a 25bp cut largely based on recent MPC communications and weakness in some key indicators of activity and inflation at the end of 2019. The main rationale for our view is that the weakness seen in recent official data relates to a period clouded by elevated uncertainty, which stands to improve reflecting both lower domestic and global uncertainty. A clear rebound in broader sentiment post general election is already apparent in recent survey evidence and should also be confirmed in tomorrow’s January PMI surveys (Note, it was confirmed). Furthermore, it may be prudent to wait for the details of the proposed fiscal package to be unveiled in the Budget on March 11, particularly if the BoE stands ready to forecast slower trend growth as part of their annual supply-side assessment in the MPR. Still, the decision is likely to be finely balanced. The MPC could make the case for a rate cut to support an expected recovery or as insurance against the slowdown continuing into 2020.”

TD Securities: “The most likely scenario is a split vote of 6-3 or possibly even the first 5-4 vote since June 2012. This is reflected in current market pricing, which is also sitting at close to 50-50 for a rate cut next week, though is fully pricing in a rate cut for by June. However, there's also a strong possibility that the BoE shifts more strongly toward an outright easing bias next week, leaving rates on hold but also leaving the door wide open to a rate cut at the next meeting in March if the hard data fails to reflect the improvement in the surveys. Either way, the Bank of England decisions over the next few months will likely be highly data-dependent, pointing to another year of high market volatility despite the more definitive general election outcome.”

Nordea: “Three factors make us go with unchanged rates in January of which a predicted PMI rebound on Friday is the main reason. Moreover, the timing of a potential rate cut would be at odds with Brexit happening the day after and the BoE’s reaction function post the Brexit referendum. Only a small PMI rebound would make us go with a rate cut instead (note, this is not what happened, PMIs showed a big rebound in January). If market pricing is >70% for a rate cut, the BoE should deliver. If the BoE cuts in January, this should not be perceived as the beginning of a big easing cycle. Risk-reward favours a slightly stronger GBP and higher Gilt yields in the coming week. On a 3-6-month horizon, however, we do expect the GBP to weaken.”


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