The Bank of England is now facing a wide-open decision on its next monetary policy move, as the August inflation data has brought about a significant downside surprise. Prior to the release of the August consumer price index (CPI), the market had priced in an 80% chance of a 25 basis point interest rate hike on Thursday, which would have brought rates to 5.5% – the highest level since December 2007. However, the market dynamics changed drastically after the annual headline CPI fell to 6.7% in August, contrary to the consensus forecast of a rise to 7%. As a result, the probability of the Bank holding rates steady at 5.25% surged from 20% to over 57%.
The surprise in the August inflation figures has set the stage for a more uncertain decision by the Bank of England. Core CPI, which excludes volatile food, energy, alcohol, and tobacco prices, decreased to 6.2% in the 12 months ending August, down from 6.9% in July. While the goods rate slightly rose from 6.1% to 6.3%, the services rate slowed significantly from 7.4% to 6.8%. The broad-based downside surprise has caught the attention of analysts and economists, putting the Bank’s decision in a more finely balanced position.
Goldman Sachs, in response to the unexpected inflation figures, changed its projection for the Bank’s rate decision. The investment bank now expects the Bank of England to keep its main bank rate unchanged. This adjustment is based on the fact that two out of the three indicators that the Monetary Policy Committee (MPC) monitors for inflation persistence have shown more progress than expected since the August meeting. Combined with recent dovish commentary, Goldman Sachs has lowered its forecast for the terminal policy rate to 5.25% from the previous estimate of 5.5%.
Barclays analysts believe that the sizable downside surprise in August inflation, especially relative to the Bank’s own projections, has made the decision more finely balanced. While still favoring a 25 basis point increase, Barclays anticipates a more dovish vote split among the MPC. Similarly, Berenberg Senior Economist Kallum Pickering suggests that the surprise in inflation strengthens the chance of a pause on Thursday, but he believes the MPC is likely to lean towards one more increase. However, Pickering emphasized that the MPC is expected to signal that further hikes are unlikely as long as inflation continues to trend lower, considering that price pressures remain above the Bank’s 2% target.
The Bank of England finds itself treading a narrow path between reining in inflation and preventing a recession amid a robust economy. The recent slew of profit warnings from British companies and the contraction of the UK economy by 0.5% in July have put additional pressure on the Monetary Policy Committee. The downside surprise in inflation could provide the MPC the “wiggle room” to adopt a wait and see strategy, according to Danni Hewson, head of financial analysis at stockbroker AJ Bell. Hewson also highlighted the delayed impact of rate hikes on businesses and homeowners, as many are now beginning to feel the effects, particularly in the form of increased mortgage payments during the expensive holiday season.
The unexpected August inflation data has significantly increased uncertainty about the Bank of England’s next monetary policy move. With market dynamics shifting and the inflation numbers defying expectations, projections and forecasts have been adjusted. The Bank is facing a finely balanced decision, and analysts and economists hold different views on what the outcome will be. As the Bank continues to balance the goal of bringing inflation back to earth with the need to avoid a recession, the next monetary policy move will have far-reaching implications for businesses and homeowners alike.
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