November BoE MPC Preview: A cautious Return to Normality


November BoE MPC Preview: A cautious Return to Normality

At one point it seemed that the economic and political chaos prompted by the Truss government’s mini-budget in September would completely upend the BoE’s plans for monetary policy. However, the subsequent succession of fiscal policy U-turns and, ultimately, the PM’s own resignation seem to have restored some semblance of normality to financial markets and mean that both official interest rates and the QT programme can resume something close to the paths that the bank originally envisaged. That said, the revolving door at No.10 Downing Street that has seen three prime ministers pass in and out in seven weeks has clearly damaged UK’s international standing. At the same time, fiscal policy will still be more stimulative than before the mini-budget. Consequently, not only over the medium-term are domestic bond yields now likely to be higher than they would otherwise have been but the bank is also widely expected to step up the pace of its tightening on Thursday.

The previous government’s proposals amounted to unfunded net tax cuts of some £45 billion a year through fiscal 2026/27 and the bank was quick to indicate that their inflationary implications would require a significant monetary response. As it is, most of the measures have been either abandoned or at least tempered and gilt yields are now back down to the levels seen just prior to the mini-budget. However, the remaining fiscal black hole is still thought to stand somewhere close to £35 billion. This implies a reduced boost to economic activity (and hence, prices) versus earlier plans, but a boost nonetheless. Consequently, market expectations are for a more aggressive move from the MPC this week. Since the current tightening cycle began last December, Bank Rate (currently 2.25 percent) has been raised at every MPC meeting, initially by just 15 basis points, then 25 basis points and most recently by 50 basis points in both August and September. The consensus for Thursday is a larger 75 basis point hike to 3.00 percent. If correct, this would match the steepest increase since September 1992’s so-called “Black Wednesday” and put the benchmark rate at its highest level since 2008. That said, the MPC’s Swati Dhingra wanted only a 25 basis point move last time while some of the more hawkish members might well want a full 100 basis points. Accordingly, nothing can be taken for granted and another split vote is very likely.

Meantime, having been delayed by a collapsing market that forced the bank to buy bonds (QE) last month. active gilt sales (QT) finally began today. However, for the time being, the auctions, of which there will be eight this quarter, will be limited to the short-and medium-maturity sectors, the longer-end having been hardest hit during the upheaval and so presumably still seen as being vulnerable. The goal remains selling £10 billion of the gilts every quarter which, with around £40 billion of redemptions also falling due, would shrink the balance sheet by £80 billion over the year. In addition, the bank will also look to offload October’s emergency purchases. Even so, there appears to be no rush and the Executive Director for Markets, Andrew Hauser, has warned that it could take the best part of five or 10 years to fully unwind QE. Note too, that the Temporary Expanded Collateral Repo Facility (TECRF), announced on 10 October to help address possible liquidity issues, will remain available until its planned closing date of 10 November.

With the economy and inflation moving in different directions, the bank’s policy decision this week will not be an easy one. However, at least the financial backdrop is now looking much less of a constraint than it did a month ago. Following the appointment of Jeremy Hunt as the new Chancellor of the Exchequer and the subsequent decision to replace of PM Liz Truss with the fiscally prudent Rishi Sunak, both the pound and the gilt market have largely recovered their earlier losses. In fact, the pound, which slumped to a record low against the dollar on 26 September, is currently trading close to 6-week highs. Nonetheless, while investors seem prepared to give the new administration the benefit of the doubt for now, the upcoming Autumn Statement due on 17 November will need to show government borrowing falling significantly over the medium-term or there will be a sizeable negative reaction. As it is, even the promise of a reduced amount of planned fiscal stimulus has still left financial markets expecting interest rates to be raised somewhat further than before the mini-budget. Futures prices currently put 3-month money rates at just under 4 percent at year-end before peaking at close to 4.75 percent in the middle of 2023. Just ahead of the September MPC meeting, next year’s high was seen at only 4.5 percent.

Thursday will also see the BoE update its economic forecasts in a new Monetary Policy Report (MPR). It will do so having seen headline inflation in September regaining July’s 40-year high.

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