Central Bank Views

BOE To Maintain Status Quo With New Comer On Dovish Side

Typography

We expect the BOE to vote 7-2 to leave the Bank rate unchanged at 0.25% and the asset purchase at 435B pound. Despite overshooting of inflation, most members would remain cautious and cite slow economic growth and Brexit uncertainty as reasons for keeping the monetary policy accommodative. However, the MPC is expected to adopt a more hawkish tone and strengthen the warning of a weak sterling. The new deputy governor Dave Ramsden would be voting for the first time. He is perceived as a dove amidst his warning of dire consequences after Brexit. He is expected to vote to maintain the status quo in the first 9-member MPC meeting since May.

Upside Surprise in August inflation

Headline CPI in the UK surprisingly rose to +2.9% y/y in August, from +2.6% a month ago. The market had anticipated a milder increase to +2.8%. The rise was driven by the +4.7% y/y jump in clothes prices and strong motor fuel prices. Core inflation rose to +2.7% from +2.4%, above consensus of +2.5% and the highest since 2011. Food inflation slipped to +2.8% from +3.3% , while energy inflation soared to +5.3% from 3.7%. Separately, input PPI improved to +7.6% y/y in August, from +6.2% a month ago, while output PPI rose to +3.4% y/y from +3.2%. It is believed that pound's weakness since the Brexit referendum is driving price levels higher. Overshooting of inflation has intensified speculations that BOE would turn more hawkish at the upcoming meeting. The BOE's OIS market is now pricing a 35% chance of a November hike, climbing to 44% in December

Soft Data Elsewhere

However, we retain the view that the MPC would remain on hold in September, and likely for the rest of the year, as macroeconomic data have remained soft. On the PMIs, although the manufacturing PMI rose to a 4-month high of 56.9 in August, it failed to offset the weakness in the services and construction sectors. The services PMI fell to an 11-month low of 53.2 while the construction PMI declined to 51.1, the lowest in a month. The services sector take up 80% og UK's economy. Consumer confidence improved modestly in August with the GfK's consumer confidence index rising to -10 from -12 in July. However, a negative reading signaled that more people were pessimistic over the economic outlook. Retail sales rebounded in August. However, risks remained to the downside as Brexit uncertainty and high inflation might constrain consumption.

The country's GDP growth confirmed at +0.3% q/q in 2Q17. The expenditure breakdown revealed that consumption growth fell to +0.1% q/q, while business investment showed no growth from both a quarter and a year ago. The job market is robust. While average wage growth has shown signs of improvement, the momentum remains way below that of inflation. This situation, if persists, would weigh on household spending.

Brexit Negotiation

The progress is slower than expected. The next round of negotiations, originally scheduled on September 18, is postponed by a week. Media reports suggested that UK's PM Theresa May was preparing to make an "important intervention" on the talks. Previous rounds of negotiations were hardly productive. While the UK urged the EU to be more flexible and to move to trade deals, the EU insisted that the “divorce bill” issue has to be resolved first. EU's chief negotiator Michael Barnier noted last week that he was “very disappointed” by the UK government as it “seems to be backtracking” on commitments to the bill.

While the hawkish members, mainly Michael Saunders and Ian McCafferty, would warn of strong inflation on the economy, the rest would consider the overall economic environment and uncertain outcome of Brexit as key factors to keep the monetary policy unchanged. However, the BOE might deliver more hawkish message, warning the market of underestimating the urgency of a rate hike.