There is little sign that the UK requires a tighter monetary policy stance. However, it looks like the ‘Old Lady’ may well be bullied into a rate hike anyway.
Clearly, headline inflation is too high. Headline CPI rose 3.1% YoY in August, and is likely to continue to rise over the remaining months of this year, and early in 2027, probably peaking around the 4% mark, if energy prices remain at, or close to, their present level.
That said, at risk of stating the obvious, the Bank of England, even with all their powers, can’t reopen the Strait of Hormuz, and can’t create barrels of oil, no matter where interest rates happen to be set.
This is why central banks focus on the underlying inflationary trends - i.e., those which their monetary policy levers can hope to control.
Here, the picture is much brighter. Core inflation held steady at 2.6% YoY in August, services inflation at 3.4% YoY, and excluding energy CPI rose just 2.4% YoY, also unchanged from a month prior. In sum, the underlying trend is not concerning.
Added to which, there remains little chance of second-round inflationary effects emerging in the UK economy. Yes, the possibility of those effects increases with every month that energy prices remain elevated, though that probability is starting from a very low level indeed.
The labour market, for instance, continues to demonstrate a remarkable margin of slack. Headline unemployment is just shy of 5%, private sector earnings are growing at a target-consistent 2.9% YoY, PAYE payrolls have fallen by around 20k for two months running, and vacancies are at their lowest level in over five years.
Furthermore, there are already signs that higher energy prices are stunting what had, up to now, been a resilient-ish demand backdrop. September’s ‘flash’ PMI survey pointed to overall output rising at its slowest pace in three months, while the latest BRC survey pointed to consumer confidence having deteriorated this month, snapping four straight months of improvement.
All this is to say that, were it not for elevated energy prices, we would in all likelihood be chewing the fat over the risks of inflation undershooting the 2% target, and debating by how much the Bank should be cutting rates. Instead, the Bank look set to be bullied into a hike, even though such a move would do nothing to resolve the energy crunch, while worsening an anaemic demand backdrop.
Put simply, with the FOMC, ECB, and BoJ having all raised rates in recent months, the BoE find themselves in the unenviable position of being the only one of the ‘big 4’ central banks not to have yet moved on policy. Even if there is little fundamental reason for the MPC to be thinking about a rate hike right now, the market clearly wants to see action, else a violent Gilt sell-off becomes increasingly likely.
Of course, one could hope for some degree of sanity in Whitehall to stave off nerves in the Gilt complex, but one could also hope for pigs to fly. Both being about as likely as the other!
So, a 25bp hike in November looks likely, with at least one more hike beyond that plausible, considering that central banks very rarely pull off ‘one and done’ moves. If such a monetary tightening does occur, though, it likely won’t be too long until the dreaded ‘R word’ starts cropping up once more, and we begin to wager when, and how quickly, the Bank must undo the tightening it has just delivered.
For markets, this means that present pricing, with SONIA implying a terminal rate just shy of 5%, looks far too hawkish. Added to which, downside risks to the GBP look to be mounting, not only as the BoE will likely tighten slower, and to a lesser degree, than peers, but also considering the dismal domestic backdrop, and ongoing fiscal woes, likely compoundint the quid’s misery further.
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