David Page, senior economist at AXA Investment Managers (AXA IM), discusses Super Thursday and concludes that today’s Inflation Report will likely pour cold water on forecasts for a 2015 rate hike.
The Bank of England’s (BoE) new communication schedule saw a bundle of announcements today. The Monetary Policy Committee (MPC) left policy unchanged, with one member dissenting and voting for a rate hike. Governor Carney presented the Inflation Report’s consumer price index (CPI) outlook that was broadly unchanged from May in years two and three, but lower in year one reflecting oil price declines.
He suggested a marginally more hawkish profile than the Bank’s conditioning assumption, but fell short of the hawkish interpretation that followed his recent speech. The report was received dovishly. We maintain our call for a February rate hike. We think the first hike debate will shift to H1 2016, from 2015/2016.
Super Thursday – the new culmination of the Bank’s decision, MPC minutes and Inflation Report combined – delivered policy unchanged with bank rate at 0.50%, Asset Purchase Facility (APF) target at £375bn, and a decision to reinvest the £17bn APF holding maturity in September.
This was all in line with expectations. The Committee saw the first divergent vote this year with Ian McCafferty voting for a 0.25% hike. McCafferty voted for hikes in 2014 and was expected to vote this way today. However, there was some surprise that last year’s compatriot Martin Weale did not join him this time, given hawkish commentary last month.
The publication of the Inflation Report provided the details of the Committee’s thinking. GDP forecasts were revised modestly higher to 2.8% for 2015 (from 2.5%), 2.6% for 2016 (unchanged) and 2.5% for 2017 (2.4%). Inflation forecasts were revised lower in the near-term to 0.3% (from 0.6%), 1.6% for 2016 (from 1.5%) and unchanged at 2.1% for 2015.
The inflation forecasts were dominated in the near-term by the sharp drop in oil prices. This is likely to delay the unwind in last year’s base effects and leaves inflation forecast some 0.4% points lower at end-2015 than in May.
Over the medium-term, inflation is projected to move back to target in Q3 2017 (from Q2) and to be modestly above target thereafter. This reflects in part slightly faster unit labour cost growth, including faster wage growth assumptions and a judgement that the disinflationary impact of sterling will be less than previously assumed, based on evidence to date from sterling’s 20% appreciation from its trade-weighted trough in 2013.
The forecasts are based on a conditioning assumption that sees rates rising from Q2 2016. Governor Carney, speaking from a personal perspective, suggested his recent Lincoln speech (where he warned about the rate hike decision “coming into sharper relief around the turn of the year”), had been motivated by a sense that for inflation to settle around 2% (rather than overshoot) in the longer-term he envisaged a profile marginally more hawkish than embodied in the rate hike.
He said this might see policy start tightening sooner, or tighten more quickly thereafter. We also note that the minutes recorded “some members saw upside risks to the inflation forecast”. We deem this as broadly consistent with our own forecast for a gradual tightening cycle beginning in February 2016, although acknowledge that a weaker short-term CPI inflation profile adds to risks that the MPC could wait until Q2 2016.
While we have maintained our outlook for a February hike for most of 2015, we have warned in recent months about increasing speculation about a 2015 hike – something that gained significant momentum after Carney’s speech. We expect today’s Inflation Report to pour cold water on these forecasts and see the interest rate debate centring around an H1 2016 hike.
Accordingly, 2-year Gilt yields have eased 4 basis points to 0.60% after today’s announcements, with 10-year yields down 6 basis points at 1.91%. Sterling reflected this dipping to $1.55 to the US dollar and £0.705 to the euro.