We have argued for some time that a near-term interest rate cut is a strong possibility. The market has now come around to this view. While the decision is a toss-up, at least until we see the next batch of data, our hunch remains that interest rates will stay on hold at 0.75% at the MPC meeting on 30th January.
- We have argued for some time that a near-term interest rate cut is a strong possibility. The market has now come around to this view. While the decision is a toss-up, at least until we see the next batch of data, our hunch remains that interest rates will stay on hold at 0.75% at the MPC meeting on 30th January.
- We have been ahead of the market and most other forecasters for some time in recognising the strong possibility of a near-term rate cut. We were the only forecaster to predict a split vote at the November MPC meeting. (See here.) And since then, we have told clients that they should expect interest rates to be cut if the data doesn’t improve in the aftermath of the general election. (See here.)
- Markets have now not only caught up with us but gone further. A barrage of comments from the MPC and disappointing data have seen the chances of a rate cut at the January meeting rise from 10% at the start of the year to 65%. (See Chart 1.) Governor Carney and external members Gertjan Vlieghe and Silvana Tenreyro, none of whom have yet voted to cut rates, have all gone on the record in the past week recognising the arguments for a near-term rate cut. Meanwhile, the slowdown in GDP growth in November suggests that growth will undershoot the MPC’s forecast of 0.1% q/q in Q4. And in December, inflation fell from 1.5% to 1.3%, below the Bank’s expectation that it would be 1.4%.
- But there are two reasons why we think investors may now have gone too far. First, the MPC’s communications were probably a reaction to the market mispricing the chance of a rate cut previously, rather than a sure-fire sign a cut is coming. As we now know, the slim chance of a cut in January priced into the market was inconsistent with the MPC’s view that one might be needed. To maintain credibility in the event the Committee decides a cut is appropriate, the Bank needed to prepare the ground.
- Second, data relating to after December’s general election will be more important to the MPC’s decision than the data relating to November and December. At the margin, the GDP and inflation figures make a rate cut a bit more likely. And with activity stagnating, inflation below target and the labour market easing, in normal times the MPC would have already cut interest rates. It hasn’t because it suspected that the general election might lead to a reduction in Brexit uncertainty that allows demand to recover.
- As such, the survey data relating to the period after the election will be crucial in deciding which way the decision goes. The Bank of England’s Brexit Uncertainty Index has fallen since the election. And the Deloitte CFO survey showed a surge in firms’ investment intentions to their highest level since early-2016. We suspect the first high-profile data covering the post-election period, such as the CBI and PMI surveys next week, will continue that pattern. (See Table 1.)
- Even so, the decision is on a knife edge. Our hunch is that rates will remain on hold on 30th January. But if the surveys don’t recover in January as we expect, we would switch to a cut. Of course, the data would need to continue to improve to prevent the MPC from cutting rates later. With Brexit uncertainty reduced and fiscal policy set to support the economy from Q2 onwards, we suspect that it will.
Chart 1: Probability of a 0.25% Rate Cut in January implied by OIS Rates (%)
Table 1: UK Data Release Timetable
Andrew Wishart, UK Economist, +44 20 7808 4062, Andrew.firstname.lastname@example.org