Enough is enough

September 2023

The economist’s corner

Are we now at the peak?

The Bank of England’s (BoE’s) Monetary Policy Committee (MPC) paused its interest rate hiking cycle in September, but the vote to do so was only passed by the finest of possible margins. Members of the MPC voted five to four in favour of holding rates, rather than increasing them by 25bps, with Governor Andrew Bailey casting the decisive vote. 

Back in mid-September, no change to interest rates was seen as a very unlikely outcome following the Office for National Statistics’ labour market release. It showed regular private sector pay, a metric examined closely by the MPC, registering at 8.1% in the three months to July, which was 0.8pp higher than the BoE’s estimate released in August. It is true, of course, that the more timely PAYE wage data indicated that pay levels are beginning to ease and there are signs of the labour market continuing to loosen. Yet, this historically high print – which is far from being compatible with a 2% inflation target –  seemed to suggest that at least another interest hike was on the cards.


However, August’s inflation numbers changed the calculus. Markets had expected y-o-y CPI inflation to increase but it actually saw a slight fall from 6.8% to 6.7%, and core inflation significantly undershot expectations with notable disinflation being observed in services prices (7.4% to 6.8%). This, along with PMI numbers registering below 50 and therefore indicating a contraction of economic activity, helped tip the balance towards the MPC holding rates steady.

So, at a base rate of 5.25%, have rates finally peaked in this cycle? We feel that we are now probably at that point although markets remain split on the issue. As mentioned in previous Rate Wraps, the full impact of the BoE’s interest rate increases will continue to filter through into the economy so rate setters may now decide simply to allow this to take its course. And, despite a pause in rates, the MPC agreed to tighten monetary policy by continuing its reversal of quantitative easing – “quantitative tightening” (QT). The MPC has agreed to reduce the size of the BoE’s Asset Purchase Programme by £100bn of gilts over the next twelve months, although the BoE would argue this will have a limited impact on tightening financial conditions. Dave Ramsden, MPC member, believes that the £80bn of QT conducted over the previous year has only added around 10bps to the ten-year gilt rate.

There has been some talk that recent increases in oil prices, driven by Saudi and Russian supply constraints, could somewhat upset the current disinflation trend and risk a second spike in inflation. This is certainly something to watch, but it seems unlikely that movements in the oil price would have anything like the inflationary impact that changes in natural gas prices have had for UK and European economies over the past two years. Bloomberg’s SHOK model, for example, suggests that oil prices moving up to $110 a barrel would only add a maximum of 0.5pp to UK CPI y-o-y inflation at any point.


Nonetheless, getting back to the 2% target will remain a hard slog. If we are at peak rates, it is likely that the MPC will hold rates at 5.25% for the rest of this year and into next year in order to continue its fight against inflation. In future Rate Wraps, we will discuss when rates may start to fall and what MPC members will be considering for future decisions. 

Daniel Mahoney, UK Economist

A view from the dealing desk

September marked a dovish shift from the Bank of England as it voted to hold rates steady, and the MPC clearly saw enough in the data to justify the move. It still proved to be a surprise to the market, as well as many forecasters, although it was perhaps slightly less surprising following the inflation numbers for August released the day before.

Headline annual inflation for August dropped to 6.7% from 6.8%, but the consensus was expecting an increase to 7%. In the annual core inflation numbers the story was similar as it fell from 6.9% to 6.2%, a much faster drop than what the consensus was expecting. These numbers follow two previous releases where the figures came out in line, or below, the consensus, and the trend seems to be for further drops going forward, although never guaranteed. This now mirrors what it being seen in developed economies elsewhere, especially in close peers such as the US and Eurozone. The diverging trends between inflation in the UK and elsewhere throughout the spring and summer of this year was the driver of market expectations for higher rates in the UK, so naturally we have seen expectations pare back too.

Markets now only attach a 50% probability of another hike by February 2024, and even this now seems potentially optimistic. The Bank of England decision was not unanimous, the vote split was 5-4 in favour of keeping rates on hold, whereas the four dissenting members opted for another 0.25% hike. The deciding factor for keeping rates on hold is seemingly the services inflation numbers for August, a measure that the MPC has highlighted as a key metric given its stickiness this year and links to wage growth. The services inflation figures for August came in well below the MPC forecasts, falling from 7.4% to 6.8% year-on-year. This compares to the MPC forecast of 7.2%. As with most things there is a caveat, as the fall in services inflation was mainly down to a fall in airfares and package holidays, which is typically volatile especially in the summer months. The MPC will treat the data with some caution, but the gap between its forecasts and reality was enough to convince some members to shift. Even though the supporting statement keeps the door open for further hikes (services inflation/wage growth play a key part here), if there is enough in the data to justify a hold now, the same seems likely come the November meeting where only one further inflation figure will be available.


Comments from members of the MPC you could argue have been positioning the markets for this in recent weeks. Governor Andrew Bailey hinted at the start of September that rates are near their peak, and Chief Economist Huw Pill in a speech in South Africa introduced his “Table Mountain” analogy, in which the emphasis of the MPC is now to tackle inflation by keeping rates consistent at an elevated level for a long period of time, rather than combating by chasing higher rates. Therefore attention has turned to what comes next. When will rates be cut? How many cuts will we see?

As always the market has its view. Looking at market swap curves we can see rate cuts are still in the equation for late summer next year, similar to where it has been for a while. Looking longer term there has been a material shift over the past month. In the five-year space markets see base rate just shy of 4%, averaging at 4.5% over the period. In the 10-year area there is however no further discount in rates, as base rate is expected to remain at that elevated (relative to the previous decade) level. The MPC, and especially Mr Pill, will likely be happy with market levels right now.


Quiet elsewhere

There is little to report from the other central bank meetings in September. The Federal Reserve kept rates on hold between 5.00%-5.25%, but also maintained its hawkish messaging. The forecasts still have one more interest rate hike to come, but markets do not see this materialising and are reluctant to budge on short-term pricing. Like in the UK, the focus remains on the longer term, and whilst further hikes are very unlikely, the Fed will continue to push the “higher for longer” narrative. Indeed it will also be content with longer-term pricing given that 10-year Treasury yields at 4.5% are more restrictive than where they were over the summer. These levels should be supported if data supports the Fed’s call that the US will avoid a recession, but nevertheless some data sources (including credit card/car finance delinquencies, ISM data,) suggest momentum will eventually wane. The European Central Bank raised its benchmark rate to 4% as expected, although some may have predicted a hold decision. This looks like the peak now, with rate cut conversations likely to be in the summer of 2024.

After the relaxation of the Bank of Japan’s yield curve control at its last meeting, markets were left disappointed that no further hawkish hints were provided by Governor Ueda in the September meeting. Instead, Mr Ueda and his deputy Shinichi Uchida in separate comments doubled down on the view that policy needs to remain easy.

Cameron Willard, Capital Markets

All data, unless otherwise stated, is sourced from Bloomberg

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