BoE preview: will rising inflation bring hawkish BoE?

Thursday’s BoE meeting looks unlikely to bring any significant shift in policy. However, with inflation on the rise, could we be set for a more hawkish shift from the MPC?

Thursday’s Bank of England (BoE) meeting is unlikely to prove too exciting for markets, with the current monetary stimulus all but guaranteed to stay the same. However, with inflation on the rise, is there reason to believe the BoE could be forced into a more hawkish mindset?

UK inflation currently stands at 1.2% (of annual CPI), representing a two-year high. Crucially we are seeing a significant culmination of both rising inflation at home due to a weak pound alongside a wider global reflation pattern. With Europe and the US all exhibiting rapidly increasing inflation, the UK is clearly heavily exposed to a double whammy effect which could see inflation well overshoot the 2% target. The chart below highlights this clear turn in fortunes for inflation.

Chart showing the rising inflation trend

November’s meeting saw the Monetary Policy Committee (MPC) provide an inflation projection of 2.5% in late 2019 – the biggest sustained overshoot since the BoE began independently setting rates in 1997. However, there is a significant trend of central bank predictions providing incorrect outlooks, largely in favor of their preferred outcome. With that in mind, it is significant the BoE has predicted such a strong number. Could we see inflation shoot well past 2%, forcing its hand?

November’s statement saw the BoE taking a ‘neutral’ stance, where it is equally likely to raise rates as it is cut them. This is quite a shift from a bank whose governor speculated back in July that we would see another cut (likely to 0.10%) in 2016.

Interestingly, the bank has provided mixed messages when it comes to its tolerance of above-target inflation. For one, the bank stated its sole target is inflation, rather than the exchange rate. However, despite this it also noted the negative impact the pound has upon inflation should prove temporary and thus an attempt to shift FX valuations and inflation via monetary policy would simply prove ‘excessively costly in terms of foregone output and employment growth.’

Does that put the idea of a hawkish pathway for the BoE to bed? Not quite. The MPC also specified that there were ‘limits to the extent to which above-target inflation can be tolerated.’

What is the truth? Well recent history dictates that despite rocketing inflation, the BoE has previously maintained rock bottom rates with a view to helping the economy. This means it will prioritise growth and jobs over its core target of inflation. However, this is dependent upon the UK economy taking a dive. As yet, we have not seen such and thus it is a race between growth and inflation where a sharp appreciation in CPI without any economic downturn in the UK economy could create significant pressure on the BoE to act. However, on the reverse, it is clear that should the UK economy deteriorate prior to inflation hitting 2.5%, it is likely the BoE will withstand a significant amount of inflation. For one thing, it is highly unlikely we will see the MPC cutting rates anytime soon given the recent trend of inflation. 

Chart showing inflation vs rates

Thursday’s meeting is unlikely to be a real blockbuster, but perhaps the story at the BoE should be regarding just how tolerant it would be should the current rate of incline persist. UK CPI has grown 1.1% in 12 months; what’s to say that this will not be replicated or even surpassed at a time where global oil prices are on the rise? With that in mind, there could be a case for sterling strength amid shifting monetary policy stance.

The weekly chart shows we are currently trading within a bearish rising wedge formation, which could indicate further downside. As such, we would need to see a break through $1.3445 to truly become bullish for this heavily sold market. That being said, just as we have seen in recent weeks, there appears to be a trend within the markets which sees value in the pound. The ability or inability to break $1.2796 will shed light on where the upcoming price action could go.

GBP/USD weekly price chart

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