BOE's Big Surprise
THE BOE SURPRISES MARKETS BY HOLDING RATES In the end, the Bank of England decided to leave interest rates unchanged. A 7-2 majority on the MPC voted to keep rates on hold at 0.1%, with Ramsden and Saunders the lone voices calling for a 15bp increase to 0.25%. The outcome was finely balanced and not the ‘dead cert’ for a rise that markets were pricing in. Most rate-setters felt that there continued to be value in waiting for additional information, particularly about near-term developments in the labour market following the end of the furlough scheme. Our full analysis is provided here. The overall message from the BoE was nuanced. It reaffirmed that interest rates would still likely need to rise “over the coming months”, which implies an increase either next month or early next year in order to return inflation back to the 2% target. UK inflation is set to increase significantly, driven by higher energy prices and supply disruptions, peaking at around 5% in Q2 next year before falling back. At the same time, there were also indications from the BoE that market pricing for interest rate rises to around 1% by the end of 2022 would likely result in inflation undershooting the 2% target at the end of the forecast period, especially if lower energy futures prices (beyond the first six months) are fully incorporated into the projections. In other words, we should expect some modest, rather than significant, monetary policy tightening in the coming year.
UK RETURN TO PRE-COVID GDP LEVEL DELAYED
The Official for National Statistics is set to confirm a slowdown in the pace of growth in the UK economy during the third quarter. We expect monthly GDP to have increased by 0.5% in September, which would result in Q3 growth of 1.5%q/q, in line with BoE estimates. That’s a significant slowdown from 5.5% in Q2. A moderation in the pace of growth was always expected since the boost from economic reopening would not be repeated, but there is widespread evidence that supply bottlenecks are hampering the ability of many businesses from meeting strong demand, hence exacerbating the slowdown. The BoE also predicts the economy to grow by around 1% in Q4, less than previously forecast. UK GDP is therefore now expected to return to its pre-Covid (Q4 2019) level in early 2022 rather than late 2021 as previously envisaged.
FED TAPER STARTS, BUT NO RUSH TO RAISE RATES
The US Federal Reserve’s policy update was ‘less exciting’ as it confirmed that it will start to taper its asset purchases from this month. The initial monthly reduction from the current rate of $120bn purchases per month would be $15bn. Assuming similar-sized cuts in subsequent months, it leaves the Fed on track to complete the tapering process at about the middle of next year. In contrast with the BoE, though, the Fed seems in no great hurry to start lifting interest rates. Meanwhile, the US economy added 531k jobs in October, more than expected, and the prior two months’ outturns were also revised up significantly. The outcome likely reflects the decline in Covid cases. The unemployment rate also fell to 4.6% from 4.8%, a new low since the start of the pandemic, while average earnings growth accelerated to 4.9%y/y. Nevertheless, with the labour force participation rate still materially below pre-Covid levels, there may be significantly more labour market slack than the headline indicators suggest. For now, the Fed continues to see current high inflation rates as being largely transitory.
US INFLATION TO ACCELERATE FURTHER
That Fed view of transitory inflation could be tested next week, with the release of October CPI inflation (Wed). We predict an increase in annual headline CPI from 5.4% to 5.8%, a three-decade high, and a rise in core CPI (excluding food and energy) from 4.0% to 4.3%. Inflation rates look set to stay elevated in the coming months but are expected to fall back during next year. Rising inflation has adversely affected US consumer sentiment in recent months. The decline in the prevalence of the delta variant, however, may offer some support to the University of Michigan’s consumer sentiment index (Fri). We look for a rise from 71.7 to 72.5 in November, although that would still be below levels that prevailed in the first half of the year.
DISMAL GERMAN DATA TO WEIGH ON EUROZONE INDUSTRIAL PRODUCTION
In the Eurozone, there will be some interest in the German ZEW survey (Tue) and Eurozone industrial production release (Fri). The ZEW is a survey of the views on economic prospects from financial professionals rather than businesses, but it sometimes provides a good early guide to business surveys. We have pencilled in modest falls in both the current situation and expectations components for November, reinforcing indications from the ECB that they are not anticipating increases in interest rates anytime soon. We also expect a fall in Eurozone industrial production in September, especially after another dismal outturn for Germany where shortages of intermediate goods appear to be having a significant impact on production.
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