5 Takeaways from the Bank of England
The MPC finds itself stuck.
It’s a strange old world when the fifth interest rate hike in seven months is seen as dovish because it was ‘only’ by 0.25%. Especially when the three dissenting voters on the Monetary Policy Committee voted for an immediate 50 basis point move and the committee as a whole signalled that more tightening lies ahead.
The minutes, as one might expect, strike a grim tone. Here are five points that caught my eye. All emphasis below, in bold, is mine.
1/Growth is undershooting the MPC’s forecasts (made last month) and they now expect a contraction in the second quarter.
14: Monthly GDP had fallen by 0.1% in March and by 0.3% in April, the latter weaker than expectations. Government services output had fallen significantly in April, as NHS Test and Trace activity had continued to decline. Manufacturing output had also fallen, below expectations at the time of the May Report. Output in consumer-facing services had risen by 2.2% in April, broadly in line with expectations.
15: Bank staff now expected GDP to fall by 0.3% in 2022 Q2, below the May Report projection of 0.1% growth. The downside news had reflected a larger than expected impact from the scaling back of Test and Trace activity in April, alongside weaker than expected market sector output growth. Relative to 2022 Q1, the slowing in growth was still expected primarily to reflect temporary factors such as the additional bank holiday for the Platinum Jubilee as well as the anticipated fall in Test and Trace activity. Intelligence from the Bank’s Agents suggested that, although there had been some early signs of a slowing in underlying growth, demand had remained mostly robust and broadly in line with projections at the time of the May Report.
This feels a little bit like the Bank trying to have it both ways. They acknowledge that Q2 growth is undershooting their forecasts (and it is worth remembering that their overall growth forecasts are already pretty weak) but reckon that much of that weakness is explainable by temporary factors such as the rolling back of Test and Trace or the Jubilee bank holidays.
Presumably neither the rolling back of Test and Trace nor the additional Bank Holiday were exactly unforeseeable when the forecasts were made in May.
(Maybe I’m wrong? Perhaps Bank stuff turned up to work on the 2nd and 3rd of June and were confused as to why the City was so quiet?)
2/The Government’s Cost of Living Package is (perhaps) a smaller deal than I assumed.
18: The Chancellor of the Exchequer had announced a £15 billion Cost of Living Support package on 26 May. This had included: a direct one-off payment of £650 for households on means-tested benefits; a payment of £300 to pensioners; and a £150 payment to people on disability benefits. There had been a doubling of the universal rebate through the Energy Bills Support Scheme, providing an additional £200 to households. The Chancellor had also announced that the original £200 rebate would no longer have to be repaid in subsequent years. The announced measures took effect over the second half of this year, with additional payments for households receiving means-tested benefits starting as soon as July. The payments to benefit recipients were skewed towards people on lower incomes.
19: Taken together, and using standard fiscal multipliers, initial Bank staff analysis suggested that these measures were likely to boost GDP by around 0.3% and raise CPI inflation by 0.1 percentage points in the first year, with some upside risks around these estimates given the targeted and front-loaded nature of some of the measures. Bank staff would conduct a detailed assessment of the new measures ahead of the August Monetary Policy Report.
Given a stimulus worth something like 0.5-0.6% of GDP, especially one targeted on those with the highest marginal propensity to consume, I’d have pencilled in something a touch higher than a 0.3% impact on GDP. Especially when one adds in the converting of the previous bill rebate/loan to an outright grant. Perhaps the Bank will when they carry out a fuller analysis?
3/Things are going to get worse on the inflation front before they get better.
23: CPI inflation was expected to rise somewhat further in the near term, to just under 10% in September, reflecting higher food, core goods and services price inflation. The recent increase in oil prices would also push up on inflation relative to the May Report projection, by around a quarter of a percentage point. Core CPI inflation was expected to rise to just under 7% by September.
24: CPI inflation was then expected to rise to slightly above 11% in October, slightly higher than the monthly peak consistent with the May Report. The projected increase between September and October was expected to be due largely to the next reset of Ofgem’s utility price cap. If sustained, the latest wholesale gas futures prices would mean around a 40% increase in the utility price cap in October, similar to the expectation at the time of the May Report.
4/The Bank is still very optimistic on the health of the jobs market.
30: Labour demand indicators had remained strong, alongside evidence of persistently elevated recruitment difficulties. The stock of vacancies had risen further, to 1.3 million in the three months to May. The vacancy-to-unemployment ratio, a measure of labour market tightness, remained elevated, within which the stock of vacancies was now broadly equal to the stock of unemployed people. Growth in the stock of vacancies had however slowed, from 5.4% in the three months to February to 1.6% in the three months to May. Recent employment indicators in business surveys and the REC labour demand index had remained strong. Intelligence from the Bank’s Agents’ contacts suggested that hiring intentions had continued to be positive and that recruitment difficulties had remained severe. Contacts had said that they expected recruitment difficulties to persist for at least the next twelve months, due to structural shortages of labour and skills.
31: Recent indicators of nominal pay growth had remained elevated, consistent with the continued effects of a tightening labour market. Nominal private sector regular AWE (Average Weekly Earnings) growth had been 4.8% in the three months to April, in line with the expectation at the time of the May Report. Adjusted for the mechanical effects of the changes in workforce composition and the Coronavirus Job Retention Scheme, Bank staff estimated that underlying nominal private sector regular pay growth had remained above 4%, also consistent with expectations at the time of the May Report and in excess of pre-pandemic rates of around 3 to 3½%. HMRC PAYE measures of median pay growth had been in a range of 4 to 6¼% over recent months, also above pre-pandemic rates. Recent strong growth in bonus payments had been broad based when compared to pre-pandemic sectoral averages. The Bank’s Agents’ contacts had reported that one-off bonus payments had been used to address recruitment and retention difficulties. Given recent developments in market-sector productivity, these underlying nominal earnings indicators also appeared to be consistent with elevated rates of unit wage cost growth.
32: The Bank’s Agents had reported that pay settlements continued to be much higher than a year ago, with deals averaging just over 5%, a little above the 4.8% expected by companies in the Agents’ pay survey conducted near the beginning of this year. A significant minority of companies were considering mid-year top-ups to pay settlements. This recent intelligence reinforced the upside risk to the MPC’s central projections for pay growth and domestic price pressures highlighted in the May Report.
It’s notable how much emphasis the minutes place on the reporting of the Bank’s agents when it comes to the jobs market.
The labour market is indeed tight but the most recent data did show some signs of softening.
None of this is conclusive, but I’m certainly more cautious on the health of the jobs market than the MPC seem to be. Certainly I worry more about downside risks in the jobs market than upside ones at the moment.
5/Rate hikes are having differing effects.
The passthrough from BOE policy changes to the mortgage market is running smoothly.
11: Lending rates for new mortgages in the United Kingdom had increased further in May, reflecting a continuing response to the increases in Bank Rate and risk-free market rates that had been observed since the autumn of 2021. Lending rates on mortgages with loan-to-value (LTV) ratios at or below 75% had risen by more than those at higher LTV ratios, such that the spread between the two had narrowed to below pre-pandemic levels. Interest rates on unsecured borrowing had also increased slightly overall. As usual, however, households’ unsecured lending rates had continued to be less sensitive to changes in risk-free rates. Rates on new lending to businesses were higher in April than in December 2021, reflecting the increases in Bank Rate.
12: Taking together all of the evidence so far, the pass-through of the increases in risk-free rates to mortgage rates since the autumn of 2021 had been greater than in 2017-18 and much closer to the full pass-through that was seen prior to the financial crisis when interest rates had been further away from the lower bound.
But, in a world where other central banks are also hiking, sterling is materially weaker than the MPC expected.
10: The sterling effective exchange rate had depreciated by around 2½% since the previous MPC meeting and by almost 4% compared to the 15-day moving average on which the May Monetary Policy Report projections had been conditioned. Sterling had been particularly weak against the US dollar. According to market participants, the recent movements had in part reflected the rising yield differential between shorter-term government bond yields in the United States compared to those in the United Kingdom, and perceptions of the UK growth outlook.
This the real problem for the MPC: it is hiking fast enough to slow an already struggling economy but not fast enough to remove the pressure on Sterling. The worry is that gains made on the inflation-front at the cost of a weaker domestic economy will be taken back by more imported cost pressures.
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