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BoE: “series” of hikes coming? - Nomura

Analysts at Nomura suggest that there are a number of reasons why they continue to see the need for faster rate rises from the BoE MPC than is currently (particularly after recent moves) priced in by the financial markets.

Key Quotes

 “First, the Bank’s two- and three-year ahead forecasts for inflation remain above target. Admittedly, the three-year forecast was trimmed very modestly, but our point here is that even though the Bank has dropped the phrase about needing to tighten more than the market expects, the sentiment for that statement (i.e. above-target inflation for the entire duration of the forecast horizon) remains in place.”

“If we assume roughly that each 25bp rise in rates reduces inflation by 0.1pp, then that would be consistent with the need for 100bp of rate hikes in order to bring inflation back to its target. And the Governor pointed out in the press conference that, while there is much uncertainty about the impact of the first rate hike in a decade, the Bank does not expect the effect to be any larger than would “normally” be the case.”

“A second point is Mr Carney’s discussion of supply potential. This is becoming a bigger issue for policymakers, because as employment growth slows (on account of it approaching its natural level), it is increasingly the rate of productivity that will govern the rate of growth of the economy’s supply potential in the future. And productivity growth has been particularly weak since the crisis. With Brexit adding to the problems (via the negative impact of greater uncertainty on investment and thereby future capacity), this means that only weak rates of economic growth or wages are now needed to be consistent with hitting the inflation target. The current historically weak rates of growth of both variables may thus be sufficient to continue hiking rates in the future. There has been a “marked slowdown that had been increasingly evident in recent years in the rate at which the economy could grow without generating inflationary pressures”.”

“To that extent, it is worth noting that many of the Bank’s remarks in relation to Brexit were devoted as much to supply potential as they were to the negative effect of uncertainty on demand. Even economic growth of 1.6-1.7%, which the MPC expects in the coming three years, may be sufficient to continue eroding spare capacity. We have seen evidence of this in recent surveys, with last month’s quarterly CBI industrial trends survey showing weaker activity growth but capacity constraints tighter than at any point in the past 20 years.”

“Third, even after recent rate rise, policy is exceptionally loose. In fact, with the way in which financial markets have moved (short sterling yields down almost 10bp, 10yr Gilt yields down 7bp and GBP/USD down the best part of 1%), monetary conditions are arguably easier after latest announcement than they were before it. If anything, the response of the financial markets makes an earlier rate more likely.”

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