BoE Hikes 50bps; Not Out of the Blue, Notable About Face 

• Today’s BoE decision may have been its best executed in the current tightening cycle. A half-point hike was a difficult trick to pull off with markets already expecting a six-handled Bank Rate.

• UK policymakers saw no option but to act decisively and hike 50bps after yesterday’s strong beat in CPI data for May. Officials are sending a strong message to Britons that the current situation is unacceptable and people must adjust patterns fast, lest inflation gets stuck well above target.

• Given today’s BoE decision and unyielding inflation, we believe the BoE is on track to hike 25bps in Aug and Sep. Practically non-existent forward guidance and risks of data surprises make projections further out trickier. Another 50bps is not out of the question.

• The market’s read was relatively contained after choppy trading, reflecting the effectiveness in communications to prevent large adjustments in either direction in rates pricing. The GBP was also mostly unperturbed, as stagflation fears loom over the currency against a 50bps hike.

Today’s BoE decision may have been its best executed in the current tightening cycle. The bank began hiking rates in December 2021, so this is a compliment as much as a critique of the colloquial ‘unreliable boyfriend’. The BoE is not alone in this club, however. The BoC also rolled out a mostly unexpected hike that our economics team anticipated as the right thing to do after not acting since January (see here).

A half-point hike was a difficult trick to pull off with markets already expecting a six-handled Bank Rate. The BoE succeeded today in delivering its largest hike since February, with limited turbulence in markets and a well-articulated statement and minutes—without the help of an MPR and press conference combo.

Bailey and the other six MPC officials that voted for a 50bps increase are sending a strong message to Britons that the current situation is unacceptable and people must adjust spending, hiring, and wages patterns fast, lest inflation gets stuck well above target. Though it may be a while before this move truly ‘hits’, there could be an important more indirect signaling effect on attitudes from a big hike. Dhingra and Tenreyro stuck to a no-change vote, unsurprisingly. Recall that this is Tenreyro’s last rate decision before Greene, seemingly on the more hawkish end of the spectrum, replaces her at the August vote.

Our latest forecast published last week, before yesterday's disappointing inflation beat, saw two more 25bps rate hikes (today and in early-August). Those 50bps are now in. Given today’s BoE decision and unyielding inflation, we believe the BoE is on track to hike 25bps at each of its next two meetings. Practically non-existent forward guidance and continued data surprises make projections further out trickier. Even the next couple of rate decisions could see another 50bps hike or, in the extreme, no more hikes—but an August hold would need huge misses in inflation and calamitous jobs/GDP data.

UK policymakers saw no option but to act decisively and hike 50bps after yesterday’s strong beat in CPI data for May, led by another jump in core inflation (7.1% from 6.8%). This inflation backdrop combines with a resilient labour market, high wages growth, and an economy that, while static since Q4-2021, stubbornly chugs along with recent data pointing to a slight pickup in activity.

This far in the cycle, after hiking a cumulative 440bps prior to today’s increase to 4.75%, the BoE really should have seen better results on the inflation front. To be fair, some UK structural issues in areas such as labour supply, and sources of and price-setting policy in energy have made the bank’s job more difficult—on top of Brexit trade frictions, a surge in food prices, etc. Strong and immediate action was nevertheless needed.

The BoE had also banked on its transmission mechanism operating more quickly, but a different make-up of mortgages than in previous cycles means it is taking longer for consumption to temper amid increased debt servicing.

According to UK Finance, just over 80% of outstanding UK mortgages are fixed rate and in late-2021—just as the BoE embarked on its hiking cycle—96% of new mortgages were taken out on fixed rates. For reference, this share stood at 50% in Canada according to BoC figures for Q4-21. In the UK, those who took out 2-yr fixed mortgages at the time may be in for, or are already seeing, a significant increase in mortgage payments. Across all homeowners, UK Finance claims that around 800k fixed mortgage agreements end in H2-23 from a pool of 8.5mn; over the totality of 2024, they estimate that about 1.6mn deals expire. From 2.5% in late-2021, the average two-year fixed rate has climbed to just above 6% as of earlier this week, according to Moneyfacts.

The focus on mortgage borrowing risks is a key component of the statement that anchored market expectations despite the 50bps increase. This provided an important counterweight and reinforced mortgage/indebtedness developments among the headline metrics, joining inflation and jobs data, that are a must-watch for calling the future policy path. Note also that the BoE has readjusted part of its focus from inflation forecasts to actual inflation figures as a determinant of policy decisions.

The BoE couldn’t afford to continue pinning its hopes on forward-looking considerations like mortgage renewals and the slow transmission mechanism. On the latter, based on their estimates, today’s 50bps increase would mean that a total of about 350bps in hikes are left in the pipeline. That is massive, at about 70% of aggregate hikes since these began. This could very well be too much. With the two more hikes that we project, this would be 400bps—and 450bps based on market pricing. If it’s too much, the BoE can adjust to keep a more adequate level of real rates as realised and expected inflation (hopefully) come down. It could be a tricky path to navigate, and there’s risks of moving too soon or too late.

The next few months of data will determine whether hikes-to-date are having a more obvious intended effect, whereas we’ll likely have to wait until the first half of next year for alarm bells to ring all over (if they do). Above all, the BoE maintained full optionality in the final paragraph of the policy decision, iterating that “If there were to be evidence of more persistent pressures, then further tightening in monetary policy would be required”. Still, the collection of upside risks to inflation that are laid out in the minutes imply that the BoE does not think it’s done with rate increases, pointing, for now, to two more consecutive 25bps increases.

Market reaction

UK rates initially sold off, 2s climbed about 4bps, but very quickly caught a bid given a lack of guidance on more hikes to fall a couple of bps, on net. After more choppy trading, 2-yr yields are up ‘only’ 5bps on the day, outperforming the US and Germany (up 6 and 7bps, respectively). The UK belly/long-end was favoured with 5s and 10s currently down 1/2bps on the day, which could reflect speculation that the BoE will ultimately have to cut more quickly from a higher terminal rate reached faster that depresses the economy. It could also be that some thought the BoE could accelerate its pace of QT, as Dep Gov Ramsden floated last week.

Contracts for the December 2023 meeting are pricing in a cumulative ~165bps in hikes including today’s, a 17bps increase versus pre-decision levels that mostly just reflects the 18bps gap in the 32bps priced in for today versus the 50bps that we actually got. Hikes priced into August contracts were already quite chunky, so the 42bps in between the June and the August meetings has only risen to 44bps, at writing. Calling back-to-back 50s confidently is a stretch, but markets (and some economists) can’t be blamed for waiting for more information before reassessing so soon towards lower hikes after a somewhat surprising 50bps increment.

Sterling, like with yesterday’s inflation beat, is not a big fan of the half-point hike. Again, growth prospects with stagflation a greater possibility after a large hike don’t bode well for the GBP, and there’s a sense that hikes pricing is stretched or at its limits. Cable is not faring too poorly with its 0.2% drop in line with the EUR’s (the EURGBP cross is flat vs pre-decision after chopping around). Note that the NOK is up 0.6% on the day after the Norges Bank announced a 50bps hike this morning, and facing similarly-priced expectations in markets ahead of the decision. Half-point hikes are made differently when one is a bicycle kick from midfield while the other is well-hit volley into the top corner from outside the box.