BoE minutes: Return to unanimity as short-term weakness prevails

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Gilles Moec, Europe economist and Sebastien Cross, rates strategist at Bank of America Merrill Lynch analyse the implication of the latest minutes of the Bank of England’s (BoE) monetary policy committee.

A return to unanimity
There was a dovish surprise to this month’s Bank of England minutes as both MPC dissenters (Martin Weale and Ian McCafferty) changed their vote in favour of holding rates constant at 0.5%. The unemployment rate came down to 5.8% for the three months to November, suggesting that slack in the labour market continues to tighten. However the downward surprise in unemployment does not appear to have put increased pressure on wages, with headline average earnings growing broadly in line with consensus at 1.7% in November.

The BoE gave an update of their short-run inflation forecasts in the minutes, indicating that they now see CPI falling to 0 in March of this year. Furthermore, they perceive there to be ‘a roughly even chance’ of it falling below 0 sometime in H1 2015. This is slightly below our forecast of a trough at 0.1% in February this year.

However, with both continued falls in oil prices and the further announcements of gas price cuts for consumers posing downside risks, this is far from inconceivable. There was increased emphasis on household and business inflation expectations, both of which have fallen recently but remain well anchored in the BoE’s view. On top of keeping a keen eye on how they progress, the BoE further cautioned that this will have knock-on effects on wage growth, as 40% of pay settlements will be agreed in April, when inflation is expected to be near its lowest.

The change in voting pattern came as a surprise, particularly from McCafferty, who had previously argued that the MPC needs to act pre-emptively before we see a material increase in wages given that the time it takes to feed through into inflation is shorter than the time monetary policy takes to have an effect on the economy. The worry now is that weak inflation leads to weaker wage growth which consequently feeds back into inflation, and the problem of weak headline inflation becomes one of weak core inflation too.

Although we agree that this is a risk, the fall in unemployment to 5.8% and continued talk of growing skills shortages in parts of the economy suggest labour market slack continues to tighten and should maintain pressure on wages. Furthermore, with lower oil prices continuing to feed through into petrol prices and broader energy prices then real wage growth should remain positive in the shortrun and support further growth in consumer spending.

Investment poses a concern to growth, as the sharp fall in oil prices will likely mean North Sea oil firms cut their capital expenditure. Furthermore the possibility of businesses delaying investment in the first half of this year due to the uncertainty posed by May’s election is a tangible risk.

Weighing up the rate hike timing
The risks are now firmly weighted towards the BoE hiking rates beyond our current call of August this year. The housing market has shown signs of slowing over the last few months, with London in particular sliding from its summer peak. The implementation of theBoE’s cap on the amount of mortgage lending banks can supply at 4.5x income multiple back in October has likely contributed. However it wasn’t just supply of credit that has been driving the slowdown, with the BoE’s latest Credit Conditions Survey showing demand for secured lending for house purchases fell significantly

The combination of the BoE’s mortgage market policies and higher real rates due to the fall in inflation expectations means that monetary conditions have tightened in the economy over the last few months without any change in policy stance from
the BoE. The combination of this and the worry of weakening inflation expectations appear to have been enough for the MPC to lighten is tone.

With the negative short-run effects of the oil price decline having a greater impact than the MPC previously expected and the positive medium-run effects yet to be seen, the BoE is likely to shy away from suggestions of a pre-emptive move in policy for the meantime. The focus of their concern is that falling inflation expectations amongst a global disinflationary trend feeds through into weaker wage growth and consequently weaker medium-run core inflation. Consequently we will likely need to see signs of strong nominal wage growth and a stabilization of short-term inflation weakness before the BoE substantially changes its rhetoric towards hiking rates again, in our view.

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