We expect the BoE to deliver another rate hike next week. The magnitude of which is still not entirely clear. Although there is a ~20% probability of a 50bps rate hike, we would lean towards a 25bps hike with a hawkish message that conveys the possibility of further rate hikes in the coming months. This would be more in line with the cautious stance of the BoE and some of its more dovish members who might prefer a more gradual tightening pace. Next week’s CPI data, to be released on June 21st, will give further indication on how persistent some of these price pressures still are. Our own forecasts for UK inflation continue to anticipate a decline in inflation by the end of this year, but still not reaching the 2% target in 2023.
There is consensus among analysts that the Bank of England (BoE) faces one of the toughest environments among developed markets central banks. Inflationary pressures in the UK remain high, with CPI +8.7% YoY and core CPI +6.8% YoY. Data published this week showed that the UK labour market remains very tight, with wages (including bonuses) rising by 6.5%, which is still below inflation levels. Not including bonuses, wages are up by over 7%, the largest increase excluding the Covid pandemic period. This is a problem for the BoE given that strong wage growth risks increasing the second round effects on inflation, i.e. a wage spiral of prices, similar to those observed in the UK during the 1970’s. The MPC committee is aware of this and made it clear at the last meeting that these effects of wages on inflation are proving to be stronger (and for longer) than they anticipated.
At the same time, activity in the UK is weak, with preliminary data showing GDP growth of 0.1% in the last three months to April. Although output in services has increased, both manufacturing and construction contracted over the last month. Therefore, additional tightening of monetary conditions by the BoE, required to bring down inflation, will have negative effects on credit, housing, and economic activity. Data published this week drove the 2-year gilt yields to 4.89%, surpassing the previous peak of 4.64% in September 2022, in anticipation of further rate hikes.
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