Wednesday morning will see the publication of May’s consumer price index figure. The Monetary Policy Committee of the Bank of England will announce its next move on interest rates. Data points show ongoing tightness in the labor market and strong underlying inflationary pressures.
Furthermore, data points indicate persistent tightness in the labor market and strong underlying inflationary pressures. Consequently, economists now expect the Bank to prolong its tightening cycle and raise interest rates higher than anticipated.
In addition, British 2-year government bond yields surged to a 15-year high of 5% on Monday in anticipation of the expected rate announcement. As a result, another 25 basis point rate increase is expected to be announced on Thursday.
Starting in November 2021, the central bank has implemented a series of hikes, raising its base rate from 0.1% to 4.5%. Moreover, market pricing suggests that the base rate may eventually peak at 5.75%. Despite a decrease from 10.1% to 8.7% year-on-year in April, headline CPI inflation remains high.
Conversely, core CPI, which excludes volatile energy, food, alcohol, and tobacco prices, experienced an increase of 6.8% compared to the previous month’s 6.2%. The Bank of England aims to address inflationary pressures and ensure stable growth through tightening measures.
Hence, the expected interest rate hike reflects the Bank’s efforts to control inflationary pressures. The rise in bond yields indicates the market’s anticipation of tighter monetary policy. The series of rate hikes by the Bank of England has been gradually pushing up borrowing costs.
Consequently, the mixed but resilient growth momentum adds complexity to the Bank’s decision-making process. Overall, these developments indicate the need for the Bank of England to navigate a challenging economic landscape.
The Strong Labour Market Data
Additionally, labor market data surprised policymakers as unemployment dropped to 3.8%. Moreover, the inactivity rate decreased by 0.4 percentage points, defying expectations.
Furthermore, regular pay growth (excluding bonuses) exceeded forecasts, reaching 7.2%. In addition, regular private sector pay, the Bank’s key metric, rose 7.6% year-on-year.
Although May PMI remained in expansionary territory, they were slightly below consensus expectations. Surprisingly, the U.K. GDP contracted by 0.3% month-on-month in March. However, it rebounded partially, with 0.2% growth in April. So, Policymakers are now facing a collective headache due to the strong labor market data.
In a research note, Goldman Sachs Chief European Economist Sven Jari Stehn expressed his views.
Stehn stated that there is a “high hurdle” for the Bank of England to increase hiking increments to 50 basis points.
Stehn highlighted that inflation expectations have remained anchored, and recent comments indicated no appetite for a faster pace. The upcoming meeting will have no press conference or new projections.
Stehn expects the MPC to acknowledge the recent data and the skewed risks to the inflation outlook.
He also expects the MPC to keep its loose forward guidance unchanged.
Nonetheless, he anticipates the MPC to acknowledge the firmer recent data and the significant upside risks to the inflation outlook.
Moreover, Stehn added that the MPC will likely keep its loose forward guidance unchanged. They support Goldman Sachs’ view and expect the MPC to maintain a relatively dovish position. This expectation is based on resilient growth, sticky wage pressures, and high core inflation.
They project the MPC to continue implementing 25 basis point hikes due to stronger-than-expected data. Eventually, they forecast the terminal rate to reach 5.25%, with risks skewed to the upside.
Similarly, BNP Paribas economists expect a 25 basis point hike on Thursday.
They emphasize that inflation expectations remain lower than when the Bank implemented 50 basis point increments. Goldman Sachs and BNP Paribas offer their insights considering various factors, including inflation expectations, growth, and wage pressures.