October 2023 / MARKETS & ECONOMY
BoE likely to hold rates, but publish a weaker outlook
We believe upcoming economic forecasts from the BoE could highlight increased risks of stagnation or recession for the UK economy.
- The Bank of England will likely keep policy on hold, with the next move likely to be a rate cut
- In its upcoming forecasts, the Bank of England could highlight increased risks of stagnation or recession going forward
- This change in projections could indicate a more aggressive rate cutting cycle than currently projected by financial markets
The Bank of England (BoE) will likely keep policy on hold at their meeting this week. It is likely that the current Bank rate of 5.25% is the peak in this cycle. The next move will likely be a cut and happen earlier than markets expect.
The latest data show that UK Consumer Price Inflation (CPI) was stickier than expected. The big downside surprise in the August release of UK CPI inflation led the Monetary Policy Committee (MPC) to hold rates in September. However, the subsequent release in September surprised to the upside, showing that UK inflation could still remain sticky for some time or only come down slowly. Nevertheless, September UK CPI inflation of 6.7% was still lower than the 6.9% figure the Bank of England had forecast in August. However, wage inflation continues to be very strong and shows no signs of peaking. Since wage inflation is the main ingredient of services and domestically generated inflation, very strong wage inflation readings imply a high risk that CPI inflation will stay significantly above the Bank of England’s target in the medium term. Nevertheless, the Bank of England has started to look through the very strong official wage data in their latest policy statement, relying on other indicators such as surveys instead. Only time will tell whether the surveys, which indicate a decline in pay pressures or the official Average Weekly Earnings (AWE) measure, which hasn’t peaked yet, is the better indicator of underlying pay pressures in the economy.
To cool wage inflation to levels consistent with target, the Bank of England needs to take the heat out of the labour market. The main reason for these strong wage inflation prints is very strong labour demand against weak labour supply. Vacancies are falling now and the unemployment rate is rising. Despite a major methodological change, the Unemployment rate is still measured at 4.2%, 0.1% higher than the Bank of England expected at this point in the cycle. My calculations show that the unemployment rate will need to rise to at 6.5% for wage growth to return to levels which are consistent with the Bank of England’s target. Output business surveys have improved somewhat on the month, but consumer confidence saw a very large drop in October. Overall, the evidence suggests that the economy is continuing stagnating, but the consumer confidence survey indicates a much faster deterioration in demand.
These data mean that the Bank of England will likely stay on hold in terms of policy this month. However, the Bank of England will also update its forecasts this month. Given the changes in the data since the last forecast meeting, I believe that the Bank of England could highlight risks of stagnation or recession going forward. Financial markets have only one cut priced in over the next year, which is one of the least aggressive cutting cycles in advanced economies. However, the UK has also had one of the strongest real economy reactions to the tightening in monetary policy. Such a change in projections could serve as an important signal of future policy to financial markets and lead to markets pricing in more cuts into the UK money market curve going forward. I believe that pricing in a larger amount of cuts would be justified given fundamental changes in the UK economy in the past couple of months. The Bank of England could therefore use its projections to indicate that it shares this assessment this Thursday.
IMPORTANT INFORMATION
This material is being furnished for general informational and/or marketing purposes only. The material does not constitute or undertake to give advice of any nature, including fiduciary investment advice, nor is it intended to serve as the primary basis for an investment decision. Prospective investors are recommended to seek independent legal, financial and tax advice before making any investment decision. T. Rowe Price group of companies including T. Rowe Price Associates, Inc. and/or its affiliates receive revenue from T. Rowe Price investment products and services. Past performance is not a reliable indicator of future performance. The value of an investment and any income from it can go down as well as up. Investors may get back less than the amount invested.
The material does not constitute a distribution, an offer, an invitation, a personal or general recommendation or solicitation to sell or buy any securities in any jurisdiction or to conduct any particular investment activity. The material has not been reviewed by any regulatory authority in any jurisdiction.
Information and opinions presented have been obtained or derived from sources believed to be reliable and current; however, we cannot guarantee the sources' accuracy or completeness. There is no guarantee that any forecasts made will come to pass. The views contained herein are as of the date noted on the material and are subject to change without notice; these views may differ from those of other T. Rowe Price group companies and/or associates. Under no circumstances should the material, in whole or in part, be copied or redistributed without consent from T. Rowe Price.
The material is not intended for use by persons in jurisdictions which prohibit or restrict the distribution of the material and in certain countries the material is provided upon specific request.
It is not intended for distribution to retail investors in any jurisdiction.
Tomasz Wieladek is the chief european economist in the Fixed Income Division in London. Tomasz is a vice president of T. Rowe Price Group, Inc. Tomasz's investment experience began in 2009, and he has been with T. Rowe Price since 2019, beginning in the Fixed Income Division. Prior to this, Tomasz was employed by Barclays as a senior international economist. Tomasz also had a number of roles at the Bank of England, including MPC advisor and senior researcher. Tomasz earned an M.Phil. in economics from the University of Cambridge and a Ph.D. in international economics from the Graduate Institute of International and Development Studies.