MNI BOE WATCH: Holds, Rates To Depend On 2nd-Round Effects

The Bank of England left Bank Rate on hold at 3.75% at its April meeting, with only Chief Economist Huw Pill backing a 25-basis-point hike in an eight-one vote, though Governor Andrew Bailey stressed that a long period of higher energy prices would mean higher rates.

The BOE did not select a specific “central projection” for the economy, the only time it has failed to do since apart from during the Covid pandemic, and instead set out three scenarios conditioned on different paths for energy prices and the strength of second-round effects.

Bailey and deputy governors Sarah Breeden and Clare Lombardelli placed weight on the median of the three scenarios - Scenario B - which implied oil prices rising slightly higher than the futures curve implies. This scenario, applying mechanistic rules, saw Bank Rate peaking in a range of 3.9% to 4.4%. (See MNI POLICY: BOE To Put Scenarios Centre Stage)

Bailey described the April decision as "an active hold" rather than merely reflective of a "wait-and-see" approach.

"It's not the case that we're ... giving a slightly covert message that interest rates are going to go up notwithstanding what we've decided today," he told the press conference.

"There's a good case for holding rates now, but we must recognise that a prolonged spike in energy prices, as in Scenario C, could lead to a higher Bank Rate.”

Scenario C, with oil prices reaching USD130 a barrel, saw Bank Rate as high as 5.5% and inflation potentially exceed 6%.

LITTLE TIGHTENING

In the minutes, Lombardelli said she placed more weight on Scenario B than the more benign Scenario A and that the tightening in monetary and financial conditions since the Iran war started was warranted.  Breeden highlighted that while this tightening in financial conditions has guarded against current second-round effects, there are two-sided risks, and that firms and workers may be more sensitive to higher prices after a prolonged bout of elevated inflation even if demand may weaken further.

Deputy Governor Dave Ramsden also identified two-sided risks as labour market conditions continued to weaken and demand is subdued, but he thought there were "upside risks to energy prices relative to futures curves" and said he placed equal weight on scenarios A and B.

Pill and Catherine Mann emphasised the risk of a persistent inflationary shock, with Pill saying that he considered the risk of second-round effects in each of the three scenarios to be skewed to the upside and Mann saying agency intelligence and the DMP Survey suggest that firms likely possess more pricing power than embodied in the scenarios. Megan Greene also expressed concern about firms' pricing power and the potential for second-round effects. (See MNI INTERVIEW: Robust Policy Backs BOE Hike - Ex-MPC Saunders ) 

FRACTURED COMMITTEE

Swati Dhingra, who had consistently voted for a lower path for Bank Rate, said that "the balance of risks around the inflation outlook has shifted to the upside," and that all three scenarios "remain in play."

Alan Taylor placed the most weight on "the zone between Scenario A and the path with standard treatment, where conflict subsides and energy prices moderate to year-end," which "would entail a hold for some time, then a move to a neutral or accommodative stance."