The Bank of England (BoE) hiked rates 25bp yesterday for the first time in a decade, as expected, with recent domestic and global macro data seemingly helping the Monetary Policy Council inch over the rate-hiking start line.
But that was not real story, with financial markets always likely to look beyond the headline decision and focus instead on the underlying message.
Markets’ dovish reaction in the past 24 hours suggests that they zeroed in on BoE Governor Carney’s view that future rate hikes would be gradual and limited.
The Sterling Nominal Effective Exchange Rate is down 1.4% to the bottom of a 5-week range and markets are now pricing only a 34% probability of a 25bp hike in February.
Carney’s cautious outlook for the policy rate’s path is in line with my expectations that macro data and the cloak of uncertainty which surrounds Brexit will limit the need and room for the BoE to tighten monetary policy.
Fundamentally, the UK economy remains fragile, with lacklustre GDP growth of only 1% in Q1-Q3 2017 lagging growth in other G7 economies, and the medium-term outlook remains uncertain at best, in my view.
Weak retail sales and household consumption growth of only 0.5% in H1 is clearly acting as a drag on overall economic growth.
A key reason is that growth in economy-wide real earnings has slowed sharply in the past two years, in turn the by-product of slowing growth in employment and real earnings.
Moreover, the household savings rate is an already very low 6% while commercial banks are looking to tighten lending standards and pass on yesterday’s rate hike to borrowers.
With this backdrop and likely slowdown in imported inflation, core and headline CPI-inflation may be close to peaking, in my view, although there is of course the no small-matter of Brexit, a known unknown of considerable magnitude.
Governor Carney’s clear message that the BoE may not need to hike much to get inflation back down to 2% in coming years is somewhat reminiscent of the US Federal Reserve’s policy stance in 2015 and 2016.
It is possible, in my view, that the BoE’s rate hiking cycle could mirror the Fed’s with the BoE only delivering one (or perhaps two) hikes in 2018, in which case markets may need to further reduce their expectations of a February 2018 rate hike.