GBPUSD slips on a dovish hold by BOE and UK political risk

·         But BOE may not cut before Sep’24 or even Dec’24 (in line with Fed) to prevent GBPUSD going below 1.20; Labor Party set to win big in July election

On Thursday, some focus of the market was also on the Bank of England (BOE) after a hawkish hold by the Fed a few days ago and also a less dovish cut by the ECB a few weeks ago as well as 2nd ‘unexpected’ rate cuts by SNB barely a few hours ago. EU/Europe is now struggling with Parliament election/political risk amid the rise of far rights, negative for EU austerity policy and positive for fiscal imbalances along with other political issues like immigration and the EU unity/concept itself. As a result, the EUR is under more pressure after a less dovish hold by the ECB a few weeks ago.

Likewise, GBP is also under pressure on British political and policy uncertainty, as the incumbent Conservative (Sunak Government) is set to lose badly against the main opposition Labor Party led by Starmer; the Conservative Party has been the ruling incumbent party since 2010 amid various PMs ranging from Theresa May, Johnson, Truss and then eventually Sunak (from 2019) amid various political/Brexit dramas and even COVID scandals (Party gate).

Ahead of the British general election in early July’24, the Labour and Conservative parties have outlined distinct policy platforms. Overall, Labour's platform centers on social investment and public service reforms funded by tax changes, while the Conservatives emphasize economic stability and incremental improvements in public services.

Economic Policies: The Labour Party aims to implement 'economics,' focusing on prudent public spending and efficiency. They plan to establish an Office for Value for Money and appoint a ‘COVID Corruption Commissioner’ to recover lost taxpayer funds. Labour also intends to abolish the 'non-dom' tax status, increase taxes on private schools, and crack down on tax avoidance to fund their programs. In contrast, the Conservatives, led by Sunak, emphasize maintaining economic stability through continued low taxes and gradual debt reduction, despite facing criticism for rising public debt.

Healthcare: Both parties pledge to address NHS waiting times. Labor plans to fund additional operations and appointments through increased revenue from tax reforms, along with targeted recruitment to enhance NHS services. They also propose a comprehensive mental health strategy and technological improvements for early diagnosis and patient self-management. The Conservatives focus on increasing NHS funding and staffing, with reforms to streamline services and improve access to private healthcare options​.

Housing and Property: Labour's "Freedom to Buy" scheme aims to help young people purchase homes and reintroduce housing targets to increase availability. They also propose significant reforms in the rental sector, including abolishing no-fault evictions. The Conservatives plan to scrap stamp duty for first-time buyers and introduce a new Help to Buy scheme, while also offering tax incentives for landlords to sell properties to tenants​

Immigration: The Conservatives have a strict stance on immigration, aiming to reduce net migration and implement stringent measures to deter asylum seekers. Labour has not detailed specific immigration policies for this election but traditionally supports more compassionate and integrated approaches.

Education: Labour plans to expand free childcare, convert classrooms into nurseries, and establish breakfast clubs in primary schools. They aim to improve early education and make schools more inclusive. The Conservatives promise to increase the income threshold for child benefit withdrawal and maintain existing childcare reforms.

Crime and Policing: Labour intends to boost neighborhood policing, tackle violence against women, and reform the criminal justice system. They plan to increase police presence, address shoplifting and anti-social behavior, and focus on preventing youth crime. The Conservatives focus on maintaining law and order, with similar commitments to abolish no-fault evictions and improve police funding.

On Thursday, as highly expected, the BOE kept all its key policy rates on hold (unchanged) for the 7th consecutive time by 7-2 votes. The BOE kept unchanged its key/reference policy bank deposit (reverse repo) rate at +5.25% and also lending (repo) rate at +5.50%, keeping borrowing costs at their highest level since 2008 GFC days (16-year). The Bank of England (BOE) decided to maintain the key policy Bank Rate (reverse repo) at +5.25% during its June meeting, as expected, with two members advocating for a cut by -0.25%.

Also, some MPC policymakers noted that the decision not to cut was ‘finely balanced’ amid consistent disinflation; i.e., unlike the Fed, ahead of the early July British election, BOE is now showing confidence that core inflation, now having 6M rolling average around +4.4% and May reading at +3.5%, may dip further below +3.0% in the coming months on a sustainable basis.

Full text of BOE’s statement: 20th June 24- Bank rate maintained at 5.25%

The Bank of England’s Monetary Policy Committee (MPC) sets monetary policy to meet the 2% inflation target, and in a way that helps to sustain growth and employment. At its meeting ending on 19 June 2024, the MPC voted by a majority of 7–2 to maintain Bank Rate at 5.25%. Two members preferred to reduce Bank Rate by 0.25 percentage points, to 5%.

Twelve-month CPI inflation fell to 2.0% in May from 3.2% in March, close to the May Monetary Policy Report projection. Indicators of short-term inflation expectations have also continued to moderate, particularly for households. CPI inflation is expected to rise slightly in the second half of this year, as declines in energy prices last year fall out of the annual comparison.

UK GDP appears to have grown more strongly than expected during the first half of this year. Business surveys, however, remain consistent with a slower pace of underlying growth, of around ¼% per quarter.

The considerable uncertainty around estimates derived from the ONS Labour Force Survey means that it is very difficult to gauge the evolution of labor market activity. Based on a broad set of indicators, the MPC judges that the labor market continues to loosen but that it remains relatively tight by historical standards.

The collective steer from a range of indicators of aggregate pay growth has continued to ease in the latest data. Services consumer price inflation was 5.7% in May, down from 6.0% in March, but somewhat higher than projected in the May Report. This strength in part reflected prices that are index-linked or regulated, which are typically changed only annually, and volatile components.

The MPC’s remit is clear that the inflation target applies at all times, reflecting the primacy of price stability in the UK monetary policy framework. The framework recognizes that there will be occasions when inflation will depart from the target as a result of shocks and disturbances. Monetary policy will ensure that CPI inflation returns to the 2% target sustainably in the medium term.

At this meeting, the Committee voted to maintain Bank Rate at 5.25%. Headline CPI inflation has fallen back to the 2% target. The restrictive stance of monetary policy is weighing on activity in the real economy, is leading to a looser labor market, and is bearing down on inflationary pressures. Key indicators of inflation persistence have continued to moderate, although they remain elevated.

Monetary policy will need to remain restrictive for sufficiently long to return inflation to the 2% target sustainably in the medium term in line with the MPC’s remit. The Committee has judged since last autumn that monetary policy needs to be restrictive for an extended period until the risk of inflation becoming embedded above the 2% target dissipates.

The MPC remains prepared to adjust monetary policy as warranted by economic data to return inflation to the 2% target sustainably. It will therefore continue to monitor closely indications of persistent inflationary pressures and resilience in the economy as a whole, including a range of measures of the underlying tightness of labor market conditions, wage growth, and services price inflation. As part of the August forecast round, members of the Committee will consider all of the information available and how this affects the assessment that the risks from inflation persistence are receding. On that basis, the Committee will keep under review for how long Bank Rate should be maintained at its current level.

Minutes of the Monetary Policy Committee meeting ending on 19 June 2024

Before turning to its immediate policy decision, the Committee discussed: the international economy; monetary and financial conditions; demand and output; and supply, costs, and prices.

The international economy:

UK-weighted global GDP was estimated to have risen by 0.5% in 2024 Q1, in line with the projection in the May Monetary Policy Report. It was expected to continue to grow at a similar pace in Q2. Growth rates across advanced economies had converged as US growth had moderated.

Euro-area GDP had risen by 0.3% in 2024 Q1. The composite output PMI had reached a 12-month high in May, accounted for in part by the manufacturing sector. US GDP had also expanded by 0.3% in Q1. Growth in both regions was expected to continue at around this pace in Q2.

In China, GDP had grown by 1.6% in 2024 Q1, accounted for in part by strength in exports. In other emerging market economies, indicators of activity such as PMIs had seen healthy growth over this period, with particular strength in India.

Since the MPC’s May meeting, the Brent spot oil price has risen by 3% to around $85 per barrel. European wholesale natural gas spot prices had increased by 12%, with a smaller increase in futures prices.

Global shipping costs had risen since the MPC’s May meeting amid longer-than-expected disruptions to routes through the Red Sea, although these costs had remained well below their pandemic-era peak levels. In anticipation of constrained shipping capacity over the second half of the year, there were indications that producers were filling inventories sooner than usual. This higher demand combined with ongoing shipping capacity constraints had been pushing up shipping rates, although there was uncertainty around the extent and timing of any potential effects on consumer prices.

Labor markets in advanced economies had remained tight overall. The US unemployment rate had increased to 4.0% in May and the vacancy rate had decreased in April, taking the vacancies-to-unemployment ratio closer to pre-Covid levels. However, non-farm payroll growth had rebounded in May by more than had been expected by market participants, suggesting continued strength in the labor market.

The euro-area unemployment rate had fallen to a historically low level of 6.4% in April. Wage pressures had remained elevated in both regions in 2024 Q1, with the wage growth component of the US employment cost index having ticked up slightly and negotiated wage growth rising to 4.7% in the euro area due to one-off payments. The Committee discussed the extent to which this wage strength could continue to push up inflationary pressures in those regions.

Headline consumer price inflation in major advanced economies has continued to be somewhat above central banks’ targets over recent months, with services inflation remaining elevated. In the euro area, twelve-month HICP inflation had been 2.6% in May, while core inflation had risen to 2.9%, slightly higher than expected by market participants. Within this, services inflation had increased particularly strongly, in part due to base effects from German transport prices. US CPI inflation had fallen marginally to 3.3% in May, while core CPI inflation had fallen to 3.4%, both slightly below market expectations.

Looking ahead, headline inflation was expected to continue to moderate in both economies, though it remains above inflation targets in 2024. Core services and shelter inflation were expected to decline at a slow pace in the United States, while energy-related base effects could lead to an uneven inflation profile in the euro area.

Monetary and financial conditions

As in recent months, major advanced economy government bond yields had seen a relatively high degree of co-movement since the Committee’s previous meeting. Within that period, yields had moved in offsetting directions in response to macroeconomic data, in particular in the United States where the news from various indicators had been mixed. More recently, yields had been affected by uncertainty related to the forthcoming French election.

Market-implied paths for policy rates across major advanced economies had generally ended the period somewhat lower than at the time of the Committee’s previous meeting, except for in the very near term. The sterling effective exchange rate had ended the period around 2% stronger. There had been greater divergence in risky asset prices across countries, where equity prices in Europe had fallen in response to political uncertainty, but those in the United States had increased somewhat.

At its meeting ending on 6 June, the ECB Governing Council had decreased its key policy rates by 25 basis points, in line with market expectations. In its statement, the Governing Council noted that, despite the progress over recent quarters, domestic price pressures had remained strong, and had reiterated that it would follow a data-dependent and meeting-by-meeting approach.

Following the announcement, the market-implied path for subsequent cuts in euro-area policy rates in 2024 had fallen from 66 to 44 basis points. At its meeting ending on 12 June, the Federal Open Market Committee (FOMC) left the federal funds rate unchanged, also in line with market expectations. The median FOMC member now expected that there would be one 25 basis point reduction in the federal funds rate in 2024, compared to three at the time of the March FOMC projections.

In the United Kingdom, Bank Rate expectations implied by market pricing had increased following the April CPI release, which showed inflation higher than expected by both the MPC and market participants. All respondents to the Bank’s latest Market Participants Survey (MaPS) expected the Bank Rate to be left unchanged at this MPC meeting. MaPS respondents had all continued to expect the next move in Bank Rate to be downward, and the median profile had implied a cumulative 50 basis points reduction in Bank Rate this year, starting in August, although this was down from 75 basis points in the May MaPS. This contrasted somewhat with the path implied by market pricing, which had suggested that the first full 25 basis point cut would occur in November.

Medium-term inflation compensation measures in the United Kingdom have been little changed since the MPC’s previous meeting. Regarding credit conditions, the 12-month growth rate of aggregate sterling net lending by banks had picked up slightly to 1.0% in April. Annual growth in net secured lending to households had picked up to a recent high, although it had remained well below rates seen before the start of the Bank Rate tightening cycle. Mortgage approvals on house purchases, an indicator of an earlier stage in the house-buying process, had fallen slightly in April after six months of consecutive increases. Quoted rates on fixed-rate mortgage products had been little changed since the MPC’s previous meeting.

The annual growth rate of aggregate sterling broad money had increased slightly to 0.4% in April. Within that, annual growth in household deposits had picked up further, reflecting a large inflow to ISAs in the most recent month.

UK real GDP had increased by 0.6% in 2024 Q1, 0.2 percentage points stronger than had been expected in the May Monetary Policy Report. Just under half of that upside news had been accounted for by stronger government services output, which had tended to be volatile and subject to significant revision over recent quarters. Market sector output growth had also been somewhat stronger than expected, however.

Monthly GDP had been unchanged on the month in April, somewhat stronger than Bank staff expectations, which had been for a greater unwinding of the strength in Q1. Business-to-business services output had risen strongly, offsetting some weather-related weakness in other components of services and the construction sector.

Bank staff now expected GDP growth of 0.5% in 2024 Q2 as a whole, stronger than the 0.2% rate that had been incorporated in the May Report. In light of this, the Committee discussed its view of the underlying trend in growth. The latest upside news to measured GDP over the first half of this year should be set against the surprisingly weak output data that had been observed during the second half of 2023.

Recent indications from official data were stronger than an underlying rate of current output growth suggested by most business surveys, which had remained at around ¼% per quarter. Those surveys had nevertheless continued to signal that companies were expecting output growth to pick up further through the course of the year. For a given view of potential supply, this could suggest a risk that spare capacity in the economy might open up to a lesser degree than had been projected in the May Report.

Household consumption had increased by 0.2% in 2024 Q1, close to expectations in the May Report. Retail sales volumes had fallen sharply in April, in part reflecting weather-related volatility in spending. Real labor income had continued to pick up. Consumer confidence had also recovered further, with households continuing to view their own personal financial situations more positively. Nonetheless, perhaps reflecting the restrictive stance of monetary policy, households had remained skeptical about making major purchases and instead favored saving. Contacts of the Bank’s Agents had reported a pickup in consumer demand in 2024 Q2 and were cautiously optimistic that growth could rise further over the course of this year.

Housing investment had been estimated to have grown by 4.1% in 2024 Q1, significantly stronger than had been expected in the May Report and perhaps indicating some easing in the impact that higher interest rates had been having. That upside surprise had reflected a continued upward trend in private housing repair and maintenance, alongside a small increase in new work after a period of pronounced weakness. The latest April housing construction output data had weakened for both of these components, in part potentially owing to adverse weather conditions. The UK House Price Index has risen over recent months.

Business investment had been estimated to have risen by 0.9% in 2024 Q1, with recent strength concentrated in spending on aircraft. The S&P Global/CIPS UK manufacturing investment goods output PMI had picked up recently, as had expected business investment growth in the Decision Maker Panel survey.

Supply, costs, and prices

The continuing labor market data quality issues were a matter of increasing concern. Owing to very low achieved sample sizes, Labour Force Survey (LFS)--based estimates of labor market dynamics were still subject to considerable uncertainties. Key labor market flow data had not yet been fully reintroduced. It was, therefore, difficult to gauge the underlying state of labor market activity. The MPC had for some time utilized a wide range of data to inform its judgments on the labor market, including official data, business surveys and intelligence from the Bank’s Agents.

The collective steer from a number of indicators, such as HMRC RTI payrolls employee data, a range of business surveys, and the Bank’s Agents’ employment scores, pointed to underlying employment growth having slowed to broadly the same rate as population growth. This was in contrast to the LFS-based estimate of employment, which had reported a sharp decline.

The deceleration in underlying employment was in part likely to have reflected a further slowing in labor demand. The volume of vacancies had continued to fall back in May to around 10% above pre-Covid levels, although the pace of decline had slowed relative to last year. This decline in vacancies had been relatively broad-based across sectors, and a similar pattern had been reflected in the sectoral declines in demand for staff reported in the KPMG/REC survey.

In part reflecting this slowing labor demand, labor market tightness had continued to ease. The vacancies-to-unemployment ratio had fallen further in the three months to April, returning to around pre-Covid levels, which were still high by historical standards. The Bank’s Agents’ contacts had reported that recruitment difficulties had eased to near to their pre-Covid levels, although this was also still a historically high level. The KPMG/REC survey indicated that staff availability had increased further in May.

Nonetheless, an indicator model of underlying unemployment, which extracted a signal from indicators such as the claimant count, vacancies, measures of recruitment difficulties, and other household indicators, had pointed to the underlying unemployment rate has been relatively flat in recent quarters, implying that the labor market was a little tighter than official data suggested. The LFS measure of the unemployment rate had increased by 0.6 percentage points since 2023 Q4.

Annual private sector regular Average Weekly Earnings (AWE) growth had eased from 6.1% in the three months to January to 5.8% in the three months to April, in line with the expectation made at the time of the May Monetary Policy Report. April was traditionally an important month for pay setting, with around 40% of the year’s pay settlements taking effect alongside the annual increase in the National Living Wage. The collective steer from a range of pay growth indicators had continued to ease, with the staff’s updated forecast for 2024 Q2 remaining in line with the projection in the May Report of annual growth of just over 5%.

Nevertheless, some recent data suggested a risk that near-term pay growth could moderate by less than had been expected in the May Report. The Bank’s Agents’ contacts had reported that recent pay settlements for 2024 were slightly above the average level recorded in the Agents’ annual pay survey presented in the February Report. Contacts from those consumer-facing businesses that were most exposed to the National Living Wage had generally reported higher settlements.

According to the Decision Maker Panel (DMP) survey in the three months to May, businesses’ expectations for annual pay growth a year ahead had eased slightly to a rate of 4.5%, which was nevertheless still elevated. A counterpoint to these upside risks was the KPMG/REC monthly pay growth indices, which had continued to suggest a downside risk to future pay growth.

Twelve-month CPI inflation had fallen to 2.0% in May from 3.2% in March. The decline in headline CPI inflation had been accounted for largely by base effects across both goods and services. The May outturn had been close to the expectation made at the time of the May Report, although downside news from core goods price inflation had somewhat offset upside news from services price inflation.

Consumer goods price inflation had continued to ease as the cost pressures from previous external shocks had dissipated further. Households’ domestic energy bills had continued to pull down headline inflation, declining at an annual rate of 27.1% in May. Food and non-alcoholic beverages price inflation had fallen to 1.7% in May compared to a peak of 19% in March 2023.

Core goods price inflation had dropped to -0.1% in May, slightly below pre-Covid inflation rates. ONS producer price data had continued to point to easing cost pressures. Producer output and input price levels had been broadly flat in May, continuing a trend observed over the past year. The signals from other indicators, such as the S&P Global/CIPS manufacturing PMI input and output price indices and import prices, had also pointed to muted cost and price pressures for core goods.

The Committee discussed recent developments in indicators of consumer services price inflation and businesses’ price-setting behavior. Services price inflation had eased to 5.7% in May from 6.0% in March. This was a somewhat higher outturn than had been expected at the time of the May Report, however. Higher-frequency measures of services price inflation had picked up in the three months to May.

Some of this strength had been accounted for by components of the services basket that were index-linked or regulated, for which prices were typically changed in April and remained in the annual inflation rate for 12 months, as well as strength in some of the more volatile components of this basket such as accommodation services. The monthly annualized inflation rates of a seasonally adjusted services price measure, which excluded indexed and volatile components, rents, and foreign holidays, had averaged 5¼% over the three months to May, close to its average since mid-2023.

CPI microdata suggested that the share of services prices that had increased, a measure of price-setting behavior, had continued to ease, although this share had remained elevated by historical standards. Evidence from the DMP survey suggested that businesses expected the frequency of service price increases to normalize somewhat further over this year. The S&P Global/CIPS PMI services input price index had risen sharply in April but had fallen close to its historical average in May. The corresponding output price index had declined to its lowest level in three years.

Evidence on how profit margins in consumer-facing services would evolve had been mixed. On the one hand, intelligence from the Bank’s Agents suggested that consumer-facing services businesses were facing price-sensitive consumers and so would find it more challenging to maintain profit margins in the face of continuing cost pressures, including labor costs. On the other hand, the latest DMP survey data suggested that businesses in consumer-facing sectors, such as wholesale and retail, and food and accommodation had experienced flat or declining profit margins over the previous year and were expecting to maintain or even slightly increase these margins over the year ahead. This suggested that margin expansion would not add significantly to inflation above and beyond realized cost growth.

Staff expected CPI inflation to increase slightly in the second half of this year, owing largely to the smaller drag on 12-month inflation from domestic energy bills.

Indicators of households’ inflation expectations, an important channel of potential second-round effects on CPI inflation, had continued to moderate and had for the most part normalized to around their historical averages. The Bank of England/Ipsos Inflation Attitudes Survey’s measure of median short-term inflation expectations had fallen to 2.8% in May, marginally below its historical average.

The corresponding measure of medium-term expectations had remained close to, but below, its historical average. The Citi/YouGov indicator of households’ short-term inflation expectations had eased to 3.1% in May, from 3.3% in April, but had remained slightly above its historical average. In contrast to developments in household measures, businesses’ price expectations, as reported in the DMP survey, had remained at more elevated levels, albeit also on a continued downward path.

The immediate policy decision

The MPC sets monetary policy to meet the 2% inflation target, and in a way that helps to sustain growth and employment.

The Committee noted that the timing of the general election on 4 July was not relevant to its decision at this meeting, which would as usual be made based on what was judged necessary to achieve the 2% inflation target sustainably in the medium term.

In the MPC’s May Monetary Policy Report projections, a margin of economic slack had been projected to emerge during 2024 and 2025 and to remain thereafter, in part reflecting the continued restrictive stance of monetary policy. CPI inflation had been expected to return to close to the 2% target in the near term, but to increase slightly in the second half of this year, to around 2½%, as declines in energy prices in the previous year fell out of the annual comparison. There had continued to be upside risks to the near-term inflation outlook from geopolitical factors. Conditioned on the market-implied path for Bank Rate at the time of the May Report and reflecting a margin of slack in the economy, CPI inflation had been projected to be 1.9% in two years and 1.6% in three years.

The Committee considered developments since the previous MPC meeting and how these informed the assessment that the risks from inflation persistence were receding. UK GDP appeared to have grown more strongly than had been expected during the first half of this year. Business surveys, however, remained consistent with a slower pace of underlying growth, of around ¼% per quarter. Contacts of the Bank’s Agents had reported a pickup in consumer demand in 2024 Q2 and most housing indicators had also shown signs of greater resilience over recent months.

The considerable uncertainty around estimates derived from the ONS Labour Force Survey meant that it was very difficult to gauge the evolution of labor market activity. Based on a broad set of indicators, the MPC judged that the labor market continued to loosen but that it remained relatively tight by historical standards.

The collective steer from a range of indicators of aggregate pay growth had continued to ease in the latest data, although there were some signs that this year’s increase in the National Living Wage (NLW) could be having a greater-than-expected impact. The Bank’s Agents’ contacts had reported that recent pay settlements for 2024 were slightly above the average level recorded in the Agents’ annual pay survey presented in the February Report.

Twelve-month CPI inflation had fallen to 2.0% in May from 3.2% in March, close to the May Report projection. Indicators of short-term inflation expectations had continued to moderate, particularly for households, which could have implications for future wage and price-setting decisions.

Services consumer price inflation had been 5.7% in May, down from 6.0% in March, but somewhat higher than had been projected in the May Report. This strength had in part reflected prices that were index-linked or regulated, which were typically changed only annually, and volatile components. Higher-frequency measures of services consumer price inflation had picked up in the three months to May. The S&P Global/CIPS PMI services input price index had risen sharply in April but had fallen back to close to its historical average in May. The corresponding output price index had declined to its lowest level in three years.

More generally, there continued to be a range of views regarding the risks of inflation persistence embodied in the CPI projection in the May Report. On the one hand, the continued unwinding of the past shocks to energy and other imported goods prices might moderate the extent to which employees and domestic firms would seek higher nominal pay and domestic selling prices to recover the reductions in real incomes that they had experienced in the past.

As headline CPI inflation and short-term inflation expectations had fallen further, inflationary dynamics could therefore adjust as rapidly on the downside as they had done on the upside. On the other hand, there remained a risk that there had been a more enduring shift in price and wage-setting behavior, perhaps associated with a higher degree of real income resistance or with changes in the relative wage structure. In addition, there was uncertainty around the near-term paths of demand and spare capacity in the economy, and hence around the extent to which these were likely to constrain domestic prices in the face of still-elevated cost pressures.

In contrast to the upside news in services consumer price inflation, core goods price inflation had been weaker than had been projected in the May Report. Although this series was often volatile, the downside news had been spread across several components of the goods basket and was consistent with broader developments in external cost pressures.

UK CPI inflation was expected to increase slightly in the second half of this year, as declines in energy prices last year fell out of the annual comparison.

The MPC’s remit was clear that the inflation target applied at all times, reflecting the primacy of price stability in the UK monetary policy framework. The framework recognized that there would be occasions when inflation would depart from the target as a result of shocks and disturbances. Monetary policy would ensure that CPI inflation returned to the 2% target sustainably in the medium term.

Monetary policy would need to remain restrictive for sufficiently long to return inflation to the 2% target sustainably in the medium term in line with the MPC’s remit. The Committee had judged since last autumn that monetary policy needed to be restrictive for an extended period until the risk of inflation becoming embedded above the 2% target dissipated. The Committee recognized that the stance of monetary policy could remain restrictive even if Bank Rate were to be reduced, given that it was starting from an already restrictive level.

Seven members judged that maintaining the Bank Rate at 5.25% was warranted at this meeting. Headline CPI inflation had fallen back to the 2% target. The restrictive stance of monetary policy was weighing on activity in the real economy, was leading to a looser labor market, and was bearing down on inflationary pressures. Key indicators of inflation persistence had continued to moderate, although they remained elevated.

There continued to be a range of views among these members about the extent of accumulated evidence that was likely to be needed to warrant a change in Bank Rate and the degree to which incremental information was leading them to update materially their assessment of inflation persistence.

For some members within this group, the return of headline inflation to 2%, while welcome, was not necessarily indicative of the required sustained return to target. Continued high levels of, and upside news to, services inflation supported the view that second-round effects would maintain persistent upward pressure on underlying inflation. Wage growth had continued to exceed model-based estimates. Indicators of domestic demand were stronger than had been expected, and the risks to the outlook for activity were skewed to the upside. For these members, more evidence of diminishing inflation persistence was needed before reducing the degree of monetary policy restrictiveness.

For other members within this group, the upside news in services price inflation relative to the May Report did not alter significantly the disinflationary trajectory that the economy was on. This view was supported by evidence that the recent strength in services inflation included regulated and indexed components of the basket and volatile components. The impact of the increase in the NLW this April on aggregate pay growth was unlikely to be as large in the future. Such factors would not push up medium-term inflation. For these members, the policy decision at this meeting was finely balanced.

Two members preferred a 0.25 percentage point reduction in Bank Rate at this meeting. For these members, Bank Rate needed to become less restrictive now to enable a smooth and gradual transition in the policy stance, and to account for lags in transmission. CPI inflation had been on a firm downward trajectory for some time and had returned to the 2% target in May. It was forecast to stay close to 2% in the short term, consistent with further easing in the labor market, forward-looking indicators of inflation and pass-through, and continued falls in inflation expectations. Given the subdued outlook for demand, the risks to inflation remaining sustainably at the target in the medium term were to the downside.

The MPC remained prepared to adjust monetary policy as warranted by economic data to return inflation to the 2% target sustainably. It would therefore continue to monitor closely indications of persistent inflationary pressures and resilience in the economy as a whole, including a range of measures of the underlying tightness of labour market conditions, wage growth, and services price inflation. As part of the August forecast round, members of the Committee would consider all of the information available and how this affected the assessment that the risks from inflation persistence were receding. On that basis, the Committee would keep under review for how long Bank Rate should be maintained at its current level.

The Chair invited the Committee to vote on the proposition that the bank Rate should be maintained at 5.25%.

Seven members (Andrew Bailey, Sarah Breeden, Ben Broadbent, Megan Greene, Jonathan Haskel, Catherine L Mann, and Huw Pill) voted in favor of the proposition. Two members (Swati Dhingra and Dave Ramsden) voted against the proposition, preferring to reduce Bank Rate by 0.25 percentage points, to 5%.

Operational considerations

On 19 June, the stock of UK government bonds held for monetary policy purposes was £696 billion.

Highlights of BOE statements and MPC outcome: 20th June’24

·         BOE leaves the bank rate unchanged at 5.25%, as expected

·         BoE Bank Rate Actual 5.25% (Forecast 5.25%, Previous 5.25%)

·         MPC will keep under review how long the bank rate should be maintained at its current level

·         Staff forecast Q2 GDP +0.5% (May forecast: +0.2%), business surveys point to underlying quarterly growth of 0.25%

·         MPC will ensure the bank rate is restrictive for sufficiently long to return inflation to the 2% target sustainably

·         The MPC notes that the timing of the UK election on July 4th was not relevant to the rate decision

·         It's good news that inflation is back at 2%, we need to be sure that inflation will stay low before cutting rates

·         Key indicators of inflation persistence continue to moderate but remain elevated

·         CPI is to rise slightly in H2 2024 to "around 2.5%" as past falls energy prices fade (May forecast: H2 CPI "around 2.5%")

·         There is a range of views on the extent of evidence needed to cut rates

·         There was upside news on services inflation & weak core good

·         The labour market is loosening but still tight by past standards

·         BoE MPC Vote Unchanged Actual 7 (Forecast 7, Previous 7)

·         BoE MPC Vote Cut Actual 2 (Forecast 2, Previous 2)

·         BoE MPC Vote Hike Actual 0 (Forecast 0, Previous 0)

Conclusion:

On Thursday, the BOE goes for a less hawkish hold but remains hawkish about the inflation trajectory amid still elevated core service inflation. Broadly, BOE MPC is now in wait & watch mode and continues to be so at least until Sep’24 or even Dec’24, in line with Fed.

The 2023 average core CPI for the U.K. was around +6.2%, while the current 6M rolling average is now around +4.4%, still substantially above +2.0% targets, although falls substantially from May’23 high around +7.1% mainly due to the fall in energy bills for the UK.

As per Taylor’s rule, for the U.K.:

Recommended policy repo rate (I) = A+B+(C+D)*(E-B) =0.00+2+ (0-0)*(6.00-2) =0+2+4.00=6.00%

Here for BOE/U.K.:

A=desired real interest rate=0.00; B= inflation target =2; C= permissible factor from deviation of inflation target=0; D= permissible factor from/projected deviation of output target from potential=0; E= average core CPI=6.00% (~6.20%)

The U.K. should have at least a 5.75-6.00% repo rate as a restrictive zone to bring down core CPI back towards +2.00% targets by 2026 without causing an outright recession and a surge in unemployment (hard landing). Presently, the repo rate of the U.K. is +5.50%; may be at the lower end of the required restrictive zone (5.50-6.50%), even after considering the likely output gap from potential around 0.50-1.00%.

In the U.K., the Government is ‘helping’ a vulnerable section of society by providing energy and mortgage subsidies (to encounter the burden of higher energy/borrowing costs/EMI) after the Russia-Ukraine and then the Gaza war, causing elevated fuel costs. The Sunak Government was also borrowing less and not ready to go for any tax cuts to control inflationary pressure. The Government is also taking various supply-side reforms/measures to increase the overall productivity of the economy along with private business capex to increase the supply capacity of the economy so that it could match with the elevated demand side and gradually bring inflation down to target/normal.

But overall, going by the present trend, higher oil, elevated & sticky core service inflation, it may take another 18 months for the U.K. Core inflation, which is now at +3.5% to fall around +2.00% targets on a sustainable basis by Dec’26. In any way, the BOE has to keep the interest rate (repo rate) at real positive levels with at least core CPI (restrictive zone) for at least 2025 to bring full price stability by 2026-27. The same is also true for the ECB and Fed; although the ECB has cut the rate once by -0.25% due to domestic political/election compulsion, looking ahead, the ECB may not cut further until at least Dec’24 (till the Fed goes for the rate cut cycle). The BOE is a more conservative central bank than the ECB and thus like the Fed, chooses to avoid any political controversy by going for rate cuts just before an election (despite elevated core inflation).

The sudden fall in UK total CPI is due to favorable base effects and the fall in energy bills.

UK’s headline CPI may surge again in the coming months as the 6M rolling average of total CPI is now running around +0.28%; i.e. an annualized rate of around +3.3%. Overall, the cost of living (total CPI) is now almost +25% higher compared to pre-COVID days (Jan’20), which is now costing the incumbent Sunak (Conservative) government in the 4th July’24 General election.

Bottom line: Summary

·         The Fed may start the long-awaited rate cut cycle from Dec’24 and may almost confirm the same by Sep’24, just ahead of the Nov’24 election

·         Fed has projected in the June’24 dot-plots -25 bps rate cut in 2024, -100 bps rate cuts each in 2025 & 2026, and -50 bps in 2027 for terminal neutral repo rate +2.75%

·         All other major G20 Central Banks including ECB, BOE, BOC, RBI, and even PBOC may be compelled to follow the Fed’s real rate action to keep present policy differential with the Fed; although ECB and BOC have cut in June due to domestic political/economic compulsions, looking ahead they may also to be on hold until at least Dec’24 or Sep’24

·         As USD, is the primary global reserve/trade currency, any meaningful negative divergence with the Fed will result in higher imported inflation, everything being equal; for example, if the ECB indeed goes for 50-75 bps rate cuts in H2CY24, while the Fed is still on hold, then EURUSD may slip further towards parity (1.0000), which will result in higher imported inflation as the EU is dependent quite heavily on imported goods, foods, and fuel/commodities; the same is also almost true for BOE and even BOC

·         In this way, no major G20 Central Bank will take such rate action/cuts alone as there is a routine/regular coordination/consultation between all major central banks for a coordinated/synchronized policy action to avoid disorderly FX movement

·         The Fed also not seeking a very strong USD as it would eventually affect US export competitiveness. Thus all major central banks are now focusing on maintaining proper balance and coordination with the Fed, whatever may be the domestic political/election, inflation/economic narrative/jawboning; they can’t afford to diverge too much against the Fed, all being equal

·         Thus almost all major G20 Central Banks including ECB, BOE, BOC, RBI, and even PBOC may not cut rates till at least Sep’24 or even Dec’24 if the Fed remains on hold till Dec’24; no central bank will go against the Fed significantly irrespective of any narrative/rhetorics and make LCU weaker against USD, causing higher imported/total/core inflation in the process; all central banks led by Fed will continue the 24/7 jawboning to keep bond yields under control (indirect YCC like BOJ) and a ‘vibrant’ financial/money/FX market

·         Accordingly BOE may also Fed, even if have a better inflation trajectory compared to the US and thus BOE may also start cutting rates in line with the Fed from Sep’24 or Dec’24

Like Europe/EU, Britain is also one of the victims of the Russia-Ukraine and Gaza war geopolitical tensions and elevated food & fuel costs along with other commodities (import-oriented economies). Before COVID, the British economy also suffered from Brexit uncertainty. In 2023, the U.S. real GDP has grown only around +0.1% and lost the 5th largest economy tag to India. British economy should also grow by at least around +2.0% from the pre-COVID/Brexit run rate of around +1.5% on an average if we believe the so-called Brexit narratives/advantages like higher fiscal spending instead of EU’s age-old austerity policies (after the 2010 debt crisis).

Like the EU, the UK is also suffering from a stagflation/stagnation-like situation amid lower economic growth, higher/elevated core inflation/cost of living and unemployment (despite masked labor data). The stagflation and consequent anti-incumbent wave is now causing the ruling Conservative government after 15 years of power (since 2010). Labor Party is set to win big in the July election, but underlying policy paralysis may remain in Britain due to never-ending political uncertainty/weak political leadership. GBP may be the victim of Britain’s political & policy uncertainty from Brexit days when it crushed from 1.50 levels.

Looking ahead, if BOE indeed goes for -75 or even -50 bps rate cuts in H2CY24 from Aug/Sep’24 despite Fed being on hold and Britain going for new Political admin (Labor Party), then GBPUSD may slip below 1.20 BOE red light zone, which may negatively affect British economy despite some advantages on export front; Britain is mainly service-oriented export economy led by banks & financial sectors (Financial capital); imported inflation will soar further. Thus BOE has to follow the Fed’s real policy action rather than jawboning and thus may be on wait & watch stance till at least Sep’24 or even Dec’24 to keep present policy rate differential largely intact. BOE has to also judge the real policies of the new Labor Government after 10 years of Conservative government in Britain.

Technical trading levels: GBPUSD

Whatever the narrative, technically GBPUSD (1.26390) now has to sustain above 1.26000 for any recovery to 1.27300-1.28700 levels; otherwise sustaining below 1.25800, it may further fall to 1.25000-1.22800 and even 1.19800-1.18800 in the coming days.