Twilight zone: Markets await ‘highly uncertain’ interest rates decision
City analysts are eagerly anticipating a “highly uncertain” Bank of England decision on interest rates that could swing prices in either direction.
The Bank’s Monetary Policy Committee is widely expected to hold interest rates at its upcoming decision at 12pm on Thursday, though analysts have warned that a vote split and hawkish messaging around the Iran war could rattle markets again.
After last month’s decision, short-term gilt yields, which reflect government borrowing costs, sharply rose as traders priced in up to three interest rate hikes in the next couple of years.
The rupture in investors’ confidence prompted governor Andrew Bailey to claim that traders were “getting ahead of themselves” though bond markets and other asset prices have remained volatile.
City researchers have warned that the varying impacts of the war in the Middle East, which has dragged on due to failed US-Iran peace talks, could pose an array of dilemmas for MPC members.
All rate-setters will provide justifications for their own votes in the minutes to the decision. The Bank will also publish a revised set of forecasts – the first monetary policy report since the war began – as well as guidance on scenarios that could denote the Bank’s thinking on the risk of inflation spiralling in the coming months.
“We see the upcoming meeting as highly uncertain from a market-reaction perspective, while we view risks as broadly balanced relative to current pricing,” Bruna Skarica, an economist at Morgan Stanley, said.
“The vote split, the messaging, the individual paragraphs and the framing of the scenarios could all shape price action in either direction, even though we expect the overall tone to be more balanced than at the March MPC.”
She added: “To paraphrase Johan Cruyff [the late Dutch footballer and manager], communicating is simple. Communicating simply is the hardest thing in the world.
“The market is after simple messages, an understandable macroeconomic anchor, and a clear strategy.”
Reading into interest rate guidance
The Bank’s last report, which was published in February, said growth would be around 0.9 per cent this year while inflation would fall to two per cent by the end of the year. Both key forecasts are expected to suffer from heavy revisions.
UBS economist Anna Titareva said the size of the changes was “highly uncertain” and added that a rise in oil and gas prices seen since March could add over a single percentage point to inflation.
A rise in food prices could mean that the Bank estimates that the inflation forecast is ratcheted up to 3.6 per cent.
Andrew Wishart, senior UK economist at Berenberg, said the main challenge for the Bank will be in judging whether higher inflation in the short term leads to a price and wage spiral, referred to as ‘second round effects’.
However, he said: “A low number of vacancies relative to the number of jobseekers and limited pricing power suggest that neither firms or workers have the power to prevent higher energy prices from eating into their profits and real incomes.”
Some City banks including BNP Paribas have suggested that some MPC members, namely chief economist Huw Pill and external member Megan Greene, could vote for interest rates to be hiked on fears of inflation surging.
Former rate-setter Jonathan Haskel, who is a member of CityAM’s Shadow MPC, said the biggest risk of the Iran war was “de-anchored inflation expectations” among Brits, which could prompt firms to raise prices at a faster pace.