Fundamental Macro

Tomorrow brings a new era of MPC communications strategy from the BoE. Gone are the one and two week gaps between the policy announcement and the press conference and minutes respectively. And instead we get what has been dubbed “super Thursday”. Starting at 12.00 we get the policy announcement (with a new statement summarising the decision), minutes from the meeting and the Inflation Report, followed by the press conference 45 minutes later. It is going to be an awful lot of information for markets to digest. The onus is on the BoE to make sure the statement, minutes and IR are all consistent in their messages. Otherwise, the follow-up to the initial price reaction could get very choppy.

Summary:

As ever, an Inflation Report month focuses the MPC’s mind on how the news (and any changes in judgements) have impacted their outlook for GDP and inflation, and hence the appropriate policy stance. This time around there are opposing forces that are likely to change the shape of the inflation forecast. Asset prices will push it down in the near-term, while somewhat better growth prospects will offset that further out. I expect that at the crucial two-year horizon that inflation will be close to the 2% target (in May it was 2.08% for 2017Q3). If it is a little above 2% and rising, the MPC are sending a signal that rates are likely to rise earlier than current market pricing.

Carney’s recent comments about the time to start hiking being clear around “the turn of the year”, an unusually hawkish-sounding David Miles speech, and comments from McCafferty on rate hikes getting closer have resulted in speculation that August will see a split vote. Some or all of the external MPC members are expected to vote for a hike. I think there is a good chance McCafferty and Weale will vote for a hike, with Forbes also a possibility. I doubt Miles will. For more on my thoughts on the market reaction to different vote outcomes see here.

As anyone who has been following my blog knows, since the start of the year I have been expecting the MPC to hike in November (see here for my most recent commentary, which also links to earlier posts). Tomorrow may be make or break for that call. It is still my central expectation, but risks are to a slightly later start. Eg If the inflation projection is less than 1.9% at two years, then I very much doubt they will go in November. The exchange rate could be the way that risk crystalises. Part of the rise reflects relative growth and rates, but part of it doesn’t. I think they will cast it as having only a short-term impact on inflation, but it is a risk to my view that they think it could be more long-lived.

News (in silghtly more detail) since the May IR

Asset prices: moves in rates, sterling and oil prices since May will all push down on the short-term inflation forecast, perhaps by as much as 0.5pp. But the impact on inflation two years ahead should be pretty small.

• Sterling ERI: 4% higher
• Mkt rates: slightly higher across the curve, rising to around 10bp higher at the end of yr 1, 20bp at the end of yr 2.
• Oil prices 15% lower

Activity: The first estimate of Q2 GDP was slightly stronger than the Bank expected back in May (by 0.1pp), although in line with more recent projections. Similarly, expectations for growth for the remainder of this year are likely to be a little higher than in May, with PMIs remaining solid, stronger-than-expected productivity and wage growth. Looking further ahead, I expect the lower oil price to give a further boost to the consumption forecast.

The downside risk to EA growth of a messy Greek exit has also passed (again, for the time being), and activity there seems to be slowly recovering. The US was clearly disappointing in Q1, but has bounced back in Q2. While EME growth continues to disappoint. The latter, also a factor in the sharp decline in commodity prices more generally in the past couple of months.

Credit conditions have also eased further, as the Bank anticipated, but this has translated into a more rapid expansion in mortgage approvals than they expected.

The impact of the new fiscal outlook contained in the post-election Budget should be minimal.

While wage growth has surprised on the upside, labour market quantities have actually been a bit softer than expected in May, with the unemployment rate projection likely to be a tenth or so higher in the near-term and participation also a little lower.

Inflation: CPI has been pretty much in line with expectations through to June, at around zero. Core inflation looks to be in line too.