Bank of England preview – inflation piling up the pressure?

The next BoE meeting is not expected to see any major changes in policy, but the accompanying statement and minutes could indicate a shift in the balance of power between hawks and doves.

Bank of England (BoE)
Source: Bloomberg

The Bank of England (BoE) finds itself poised between a rock and a hard place. Inflation has hit its highest level in over two years, at 1.8% for January, with the rate of price growth having steadily climbed from 0.9% in October. Indeed, we only have to look back to April 2016 to find just 0.3% year-on-year price growth. This is due to the twin blows of higher oil prices and a devaluation of sterling that is, effectively, importing inflation due to the higher cost of imports. Core inflation, removing the impact of oil and food, was 1.6% in January, but even this has steadily climbed since its low of around 0.6% in mid-2015.

While the normal approach would be to raise interest rates, the bank has to deal with a highly uncertain outlook for the UK economy, with Brexit and now a potential second Scottish referendum casting a gloom over the next few years.

The bank has already signalled its willingness to tolerate some inflation above its target level of 2%, and this is likely to be reiterated. In the face of such a cloudy outlook, it would indeed seem prudent to allow the economy to run a little hot. The recent plunge in crude oil prices could also help to take the pressure off a little, although the data for this will not come through for some time.

Higher inflation poses a risk to consumer spending, and hence to economic growth. Growth forecasts are still reasonably upbeat, with the Office for Budget Responsibility suggesting 1.4% this year, 1.6% in 2018, 1.7% in 2019 and 1.9% in 2020. But the bank knows that all this is highly dependent on consumer confidence, while the longer-term forecast will be reliant on a deal with the EU that does not pose a threat to UK trade. And then there is Scotland, a new referendum might not happen by 2019, but it throws another unknown into the works.

We can expect to see the inflation hawks being a little more vocal in the minutes, but this would probably serve Governor Mark Carney quite well. It allows him to show the Monetary Policy Committee (MPC) is responsive to the dangers of inflation, but leaves policy unchanged in order to provide room for growth.

In terms of market impact, a slightly more hawkish tone to the MPC minutes should help lift sterling. We have seen the currency hold $1.2150 this week, despite a wobble on 14 March. Much will depend on the Federal Reserve meeting on 15 March, but if this is less hawkish, we could see upside for GBP/USD should it post a daily close above $1.2250. This would open the way to a possible rally back to $1.26. 

IGA, may distribute information/research produced by its respective foreign marketing partners within the IG Group of companies pursuant to an arrangement under Regulation 32C of the Financial Advisers Regulations. Where the research is distributed in Singapore to a person who is not an Accredited Investor, Expert Investor or an Institutional Investor, IGA accepts legal responsibility for the contents of the report to such persons only to the extent required by law. Singapore recipients should contact IGA at 6390 5118 for matters arising from, or in connection with the information distributed.

This information/research prepared by IGA or IG Group is intended for general circulation. It does not take into account the specific investment objectives, financial situation or particular needs of any particular person. You should take into account your specific investment objectives, financial situation or particular needs before making a commitment to trade, including seeking advice from an independent financial adviser regarding the suitability of the investment, under a separate engagement, as you deem fit. No representation or warranty is given as to the accuracy or completeness of this information. Consequently any person acting on it does so entirely at their own risk. In addition to the disclaimer above, the information does not contain a record of our trading prices, or an offer of, or solicitation for, a transaction in any financial instrument. Any views and opinions expressed may be changed without an update.

See important Research Disclaimer.

Find articles by writer