BoE’s next move unpredictable amid mixed data

As the Bank of England’s Monetary Policy Committee (MPC) gears up for its next meeting, market expectations are divided on the central bank’s next move to tackle soaring inflation. The MPC finds itself at a tipping point in its battle against rising prices in the UK economy.

As of Tuesday morning, the market showed a 62% likelihood that the MPC would opt for a 25 basis point interest rate hike, taking the main Bank rate to 5.25%. On the other hand, 38% of market participants expect a second consecutive 50 basis point hike, following the central bank’s surprise bumper increase in June. While UK inflation has slightly eased, it remains considerably higher than in other advanced economies and well above the Bank’s 2% target.

Recent data showed headline consumer price inflation dropping to 7.9% in June from 8.7% in May, with core inflation (excluding volatile energy, food, alcohol, and tobacco prices) standing at 6.9% annually, down from May’s 31-year high of 7.1%. The British Retail Consortium’s data revealed a cooling of annual shop price inflation from 8.4% in June to 7.6% in July, indicating a possible improvement in the prolonged cost-of-living crisis.

Despite the Bank of England’s consecutive rate hikes, the British economy has shown resilience, avoiding a recession. However, inflationary concerns persist, and the MPC will closely watch three indicators to gauge the necessity of additional monetary policy tightening: slack in the labor market, wage growth, and services inflation.

Goldman Sachs analysts noted that the labor market activity softened notably in May, following a strong April report. However, wage growth in the private sector remained firm, rising to 7.7%. While core inflation surprised to the downside in June, services inflation momentum remained strong. The MPC’s assessment of incoming data since June remains uncertain, leading to a close call in this week’s meeting.

The U.S. Federal Reserve and the European Central Bank also implemented quarter-point hikes last week, maintaining a hawkish stance due to inflation remaining above target.

Initial PMI readings for July showed continued economic momentum slowdown, especially in the services sector, where the Bank of England’s aggressive rate hikes appear to be impacting demand. Consumer confidence fell sharply, and unemployment, though slightly loosening, remains tight at 4%. Observers slightly favor another substantial rate hike on Thursday.

Barclays believes a half-point increase is likely, considering high wages and core inflation, which would enhance the MPC’s credibility. BNP Paribas economists echo a similar sentiment, stating that the MPC is likely to “front-load” tightening based on Governor Andrew Bailey’s previous comments.

Goldman Sachs anticipates further 25 basis point rate increments, leading to an eventual peak rate of 5.75%. This projection depends on factors like the growth outlook, labor supply, and the formation of inflation expectations, as achieving a sustainable return to the 2% headline inflation target remains uncertain.

As the Bank of England’s decision looms, the MPC faces the challenge of finding the right balance between curbing inflationary pressures and sustaining economic growth.