MNI POLICY: Perceptions Gap Between BOE Projections And MPC

Bank of England moves to gradually implement recommendations on improving its communications and forecasting risk a continuing gap between perceptions of the quarterly inflation projections and the views of Monetary Policy Committee members, as revealed by its voting patterns and minutes.

The May policy decision and minutes already appeared to sit uneasily with May's central inflation projection, with the forecast at the two-year horizon lowered by 0.4 percentage points to a below-target 1.9% on a lower market rate path. That would have conveyed a dovish message had the MPC’s vote to cut Bank Rates by 25 basis points not been surprisingly split three-ways, with two members arguing for a hold and with most of the five members who backed 25bp expressing caution over easing. 

They saw the decision as "finely balanced" before "the latest global developments," in an apparent reference to trade frictions. This caught analysts off guard, with expectations having been for the debate to centre over whether to cut by 25bps or 50bps.

The disconnect with expectations came as the Bank moves to de-emphasise its central economic forecast, which had been until now a product of “the best collective judgement of the Committee.” Former Fed Chair Ben Bernanke, who led a review into the Bank’s communications which was published in April 2024, had criticised this formulation, noting that the term was undefined, and BOE Governor Andrew Bailey has agreed with him, describing it as "ambiguous, open for discussion and negotiation."

The Bank is now moving to turn its central projection into a staff-driven, though still MPC-owned, baseline based on a market rate path, accompanied by different scenarios associated with BOE assumptions about alternative future rate paths, though these were not published in May’s Monetary Policy Report. However this incremental approach to implementing Bernanke’s reforms risks wrong-footing investors and analysts. (See MNI POLICY: Time Needed For BOE To Make Bernanke Changes)

It remains unclear exactly how far the BOE has already got in changing its forecast procedure from best collective judgement, with the process incomplete in May. In a speech last Friday Bailey said there would be a move to a “baseline projection, based on a staff proposal," which the majority of the MPC simply accept as "reasonable" - seemingly a lower bar for signing off on the forecasts. 

SCENARIOS

The fact that some MPC members portrayed global trade developments as decisive in persuading them to back a cut also sat uneasily with BOE analysis downplaying the impact of goods tariffs on the services-dominated UK economy. The projected hit to the level of GDP peaks at just 0.3% in three years’ time, while reducing inflation by 0.2 percentage points in two years’ time and 0.1 points in three years.

The BOE has also begun to produce alternative economic scenarios, selected by Bank staff, which were whittled down to two from the previous three at the May meeting, with one exploring the risk that demand weakens more than expected and the second investigating a more persistent inflationary environment due to supply constraints and second-round effects. But the read across from the newly-introduced scenarios to policy will be complex, with Deputy Governor Dave Ramsden telling May’s press conference that MPC members might identify with part of one scenario and part of another. (See MNI POLICY: BOE's New Scenarios Risk Clouding Rate Message)

While the scenarios published in the MPR only used the market rate path, Deputy Governor Clare Lombardelli sketched out alternative rate paths for each at the recent Watchers conference. Bank Rate would be almost 50 basis points lower after three years in the lower-demand scenario than in the baseline path and about 25 basis points higher in the persistent-inflation scenario, she said.

However, MNI understands that the gradual pace of rate changes in both scenarios referred to by Lombardelli was the product of using the smoothed rate version of the BOE’s loss function calculation, suggesting that the actual policy response could be faster.

This Tuesday, at an LSE event, Chief Economist Huw Pill, who voted against a cut, cited the risk of the "sort of structural change in price and wage behaviour [that] may be driven by the type of things that were embodied in the models... from the 70s and 80s" with real income resistance and the possibility of "somewhat more aggressive" policy.