Will BoE Turn More Hawkish Ahead of UK Election?

With Inflation Rising Fast, Could the BoE Be Forced to Consider Raising Interest Rates?

The Bank of England finds itself in another tight spot when it meets on Thursday – or Super Thursday as it’s become known since the addition once a quarter of the inflation report and Governor Mark Carney’s press conference.

It seems that policy makers at the central bank have found themselves in a permanent tight spot since last June’s referendum. The constant balancing act of trying to manage the UK through a highly uncertain period of higher inflation and lower growth while try to maintain accurate forecasts is a rather unenviable position. On top of this, the bank has faced constant fierce criticism regarding it pre-referendum position on what Brexit would mean for the economy and the fact that the impact has so far been more muted.

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To complicate matters even further this month, the central bank must make its latest decision – which is likely to be a straightforward “no change” – and provide new forecasts less than a month before the UK once again heads to the polls to vote in a snap general election, called by Theresa May in an attempt to solidify her position as she prepares for Brexit negotiations with the EU. Needless to say, I think Carney and other policy makers will keep their opinions firmly to themselves on this occasion.

What traders will be most interested in though is the BoEs expectations for inflation and interest rates. One policy maker – Kristin Forbes – has already voted for a rate hike and is likely to again on Thursday. Whether any other policy makers follow will likely depend on whether inflation forecasts have risen, by how much and what impact this has had on consumer inflation expectations. The latter would be the greatest concern for the central bank as it could result in temporary above target inflation becoming permanent.

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Inflation has been on the rise since the June referendum and with CPI inflation currently at 2.3% and core CPI inflation at 1.8% (BoE target is 2%), the forecasts will be key. The BoE previously claimed that it expected inflation to rise to 2.8% in the first half of 2018 before gradually falling back to 2.4% in three years. Should the latest forecasts point to higher inflation expectations, this could convince more policy makers to join Forbes in voting for a hike at an upcoming meeting.

The timing of the report tomorrow is clearly not ideal, coming less than a month before the election. It will therefore be interesting to see just how far the central bank deviates from its previous message on both inflation and interest rates, or whether it actively seeks to avoid changing course given the proximity to the election. A rate hike seems extremely unlikely tomorrow but should expectations rise and more policy makers vote for a hike, then rate hike expectations would likely be brought forward which could be bullish for sterling and UK yields.

Whatever happens, given the sheer volume of information coming from the BoE tomorrow, I would expect UK markets to be volatile.

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