BoE Preview: Banks expect 25 bps, door open to further hikes

We expect the BoE to raise rates by 25 bps, then again in August and September. Last week’s strong labour market report reduces the likelihood of the Bank doing nothing in June, raises the risk of 50 bps. We would not be surprised to see a three-way split in the voting – two for no change, six for +25 bps and one member for +50 bps. We stick with our call of a September peak of 5.25% (+75 bps from here). There’s a chance that the MPC will try to massage down market pricing by talking about policy transmission lags, or more explicitly indicating that the bulk of the MPC’s work is done.

The MPC is likely to hike Bank Rate by another 25 bps to 4.75% as risks of more persistent inflationary pressures are materialising. In fact, the overshoot in the labour market and inflation data were so bad we now expect the MPC to also hike in August, taking the peak in Bank Rate to 5%. The fundamental concern of the MPC is that a combination of excessively high inflation and a still-very-tight labour market will lead to persistently high inflation. Given the fact these concerns are only intensifying, there is a significant risk that further increases will be necessary after August.

A 25 bps hike, bringing Bank Rate to 4.75%, is virtually guaranteed, and is our base case, with a 2-6-1 vote. We expect the MPC to keep its guidance roughly unchanged, but to explicitly push back against market pricing.

We expect the BoE to hike the Bank Rate by 25 bps. While we now expect a peak in the Bank Rate of 5.00%, we see current market pricing of a peak in policy rates of 5.75% as too aggressive. EUR/GBP is set to move higher on the statement as we expect the BoE communication to fail to live up to market expectations.

The BoE has some more wood to chop. We expect another 25 bps hike that will lift the policy rate to 4.75%. This has been our forecast since October 2022. The upside risks to embedded inflation we flagged previously have materialised. We, therefore, add two more 25 bps hikes to our forecasts and now see rates reaching 5.25% this summer. Past policy tightening has yet to pay off. The central bank may push back a bit against excessive market pricing, but can’t afford to change its guidance. Even as the BoE was among the first of the large central banks to engage in rate hikes, the UK's inflation persistence means it will be among the last to complete its hiking cycle.

Given the latest jobs report showed a big increase in wage growth, and food inflation is soaring near record highs, it is tough to argue that the Bank should stop now. True, higher interest rates won’t bring down the cost of milk and cheese; but, as Governor Bailey pointed out recently: ‘we have to focus on food and core inflation’. Our base case is still 25 bps, but we wouldn’t be shocked if the 50 bps card is pulled out of the hat.

BoE terminal rate pricing has shifted 100 bps higher since the May meeting to a 5.5% peak rate in response to nominal data strength, with the market contemplating reacceleration to 50 bps increments. The BoE may not pushback directly given the staggering run of upside surprises recently, especially in UK nominal data (inflation/wages). The BoE has long been warning of upside inflation risk and won’t want to send any signal of complacency. But perhaps, the BoE may be more subtle by hiking just 25 bps this week to a 4.75% cash rate and not reincluding ‘forceful’ in the guidance.