A creaking consensus
21 March 2017
Cracks are starting to appear within the MPC. Last week's meeting saw no change to the BoE's current policy settings, as widely expected. However, this decision was not unanimous, with Kristin Forbes' vote for an immediate rate hike catching the market off guard. Moreover, there were other hints within the meeting minutes that the Bank is becoming more divided. Indeed, "some members noted that it would take relatively little further upside news on the prospects for activity or inflation for them to consider a more immediate reduction in policy support". Furthermore, there were "differing degrees of confidence" expressed in the February Inflation Report forecasts for a slowdown in activity. Nine months after the EU referendum the Bank is becoming even more divided on how the fallout will affect the economy, if at all.
There are a few reasons why the fault lines are building. The resilience of the economy in the wake of the referendum has shaken confidence in the Bank's outlook. While the Bank revised up its growth expectations in February, it is still forecasting a clear slowdown in sequential growth performance. Moreover, some members are sceptical that this is even taking place. Additionally, the decision to revise up its view on labour market slack was probably controversial within the MPC. Therefore, the minutes probably better reflect the vigorous debate around these issues. In terms of our lone dissenter; Kristin Forbes had repeatedly warned that her tolerance for above-target inflation was waning as activity data held up. Since the February Inflation Report it has been announced that she will leave the MPC in the summer, so the timing of her dissent could suggest a desire to try and shape the debate before exiting. Finally, the Bank might have one eye on market expectations for future policy. Markets had priced out any chance of an interest-rate hike over the next two years after the February Inflation Report. However, the March press statement provided a reminder that these forecasts were consistent with a modest withdrawal of monetary stimulus over coming years. Following last week's slightly more hawkish signals the market is again pricing some gradual tightening (see Chart 4). Given the uncertainty over its forecasts the MPC might be happier with the balance of these expectations.
The performance of the economy in coming months will be critical for determining the next move from the Bank. It has flagged three key assumptions to monitor; that rising inflation does not feed through to long-term expectations, pay growth remains modest and growth slows as household spending softens. Certainly there is little to suggest at present that the rise in inflation is set to be anything other than temporary. Indeed, the minutes noted that pay growth has been notably weaker than expected (see Chart 5). The activity side remains a more open question. Bank staff revised up their expectations for Q1 growth to 0.6%q/q and the minutes played down the recent weakness in retail sales. We continue to expect growth to slow more than the Bank is currently forecasting, as a squeeze in real income growth weighs on household spending. This should provide scope for the Bank to keep policy unchanged. However, if this assumption proves too pessimistic, and the economy holds up, then it is perfectly reasonable to expect the Bank to start removing some of its policy accommodation by early 2018.
James McCann, UK/Europe Economist