BoE leaves rates unchanged, GBP drops further as investors look for more clarity
11:45, 21 September 2023
The Bank of England (BoE) has kept rates unchanged at 5.25% to the surprise of markets after a 5-4 vote split.
Four members – Jon Cunliffe, Megan Greene, Jonathan Haskel and Catherine Mann – voted to raise rates to 5.5%. The remainder, including Governor Bailey, voted to keep rates unchanged for the first time since December 2021. Since then, there have been 14 consecutive rate hikes with a total of 540bps of tightening.
The decision has been justified to some extent by the August CPI data released on Wednesday, which came in softer than expected. After the data, market expectations dropped regarding further rate hikes from the BoE. The market-implied probability of a hike dropped from 79% the day prior to the CPI release, to 50% as the data came out, coming back up to 63% just before the meeting took place.
The overnight index swap curve (OIS) which measures the expectations about the future rate path, has shifted continuously this week as it has adapted to changing expectations. As the Reuters chart included below shows, the current curve (in blue) is significantly lower for the next 12 months than where it was on Tuesday (black line) prior to the CPI data release, and on Wednesday (brown line) as the CPI data came in lower than expected. This highlights the fact that investors are less convinced that the rate will indeed be raised much further in the next year.
Change in OIS curve pre-CPI, post-CPI, and post-BoE.
GBP – which had been trading softer this week on expectations that the central bank could start to show signs of weakness in its commitment to combat inflation – has seen further selling after the decision to keep rates unchanged. The consensus takeaway seems to be that this is a hawkish pause, just as we saw from the Federal Reserve on Wednesday. But with inflation still at 3 times the 2% target, it's likely that many may wonder whether this decision is sufficiently justified.
GBP/USD daily chart
Looking at how the rate curve has shifted post-decision, there are 18bps of tightening currently priced in by March next year, which amounts to around an 80% chance of further tightening. The first rate cut isn’t priced in until December next year.
From the meeting minutes, we can see that some Monetary Policy Committee (MPC) members believe inflation has fallen a lot in recent months and will continue to do so. Others – likely those who have voted to raise rates at this meeting – believe the August CPI is just a one-off, and does not reflect the real path of price pressures. Regardless, Bailey’s messaging about the possibility of future rate hikes has given a hawkish tone to this rate pause, but most will likely be less convinced than what they were with the Fed’s hawkish rate pause.
Both the ECB and the Fed had been seen as points of reference heading into this meeting. The former hiked rates at their latest meeting, but signalled the likely end of the hiking cycle for now. The latter, as mentioned above, kept rates unchanged, but signalled further rate hikes are likely to ensure inflation comes down to its intended target in the near future, as mentioned in the meeting statement.
The BoE situation is very different from either of these two, but any of these options could have been seen as justifiable from the bank’s perspective. That said, with inflation seemingly falling but still very elevated, and with growth almost stagnant, markets were likely going to find any decision fell short of what was needed, unless the bank was decisive in its hawkish stance, delivering a hike and guaranteeing more to come.
And this is why we’re seeing a bit of unsettling in UK markets, with an initial selloff in GBP and a rise in yields. Whilst a rate hold is supportive for stocks, the fact that inflation remains so elevated and growth has slowed considerably, it’s likely that companies and investors aren’t feeling so optimistic about the future, which is causing a lot of resistance in the FTSE 100 to continue pushing higher. The outlook remains uncertain at this point, so it seems like once again, only data will tell where markets go next.
FTSE 100 daily chart