The September ’17 MPC meeting: Higher August CPI print highlights the risk of a hawkish surprise

By Shilen Shah, Bond Strategist at Investec Wealth & Investment

Thursday’s MPC meeting is likely to provide further information on the central bank’s policy outlook.

However, given that the central bank won’t be publishing an updated inflation forecast or engage in a press conference, market participants are likely to scrutinise the minutes to judge whether there has been any shift in opinion within the committee.

On the data front, recent UK survey data has been tepid, with the widely followed PMI indices showing that the dominant service sector largely trading water against its historic average. The manufacturing sector is doing somewhat better due to a better global picture and more competitive FX rate, however it remains too small to move the dial. Importantly, the recent improvement in global sentiment seems not have a significant effect on the UK survey data. As with the business survey, consumer confidence seems to be drifting lower, with the GFK next-12 month Sentiment index significantly lower than its 2014 peak.

Bank of England 2 (PD)

Despite the weak domestic backdrop, one potential issue for the central bank is inflation. The overshoot in the August Inflation print (YoY CPI: 2.9%, Core CPI: 2.7%) in today’s ONS release has led to a sharp rally in Sterling’s value against both the USD and Euro. However relative to Sterling’s historic average, it is currently near a 5-year low (on a trade-weighted basis). The historic relationship between the GBPEUR FX rate and forward interest rates seems to have broken down since the Brexit referendum –suggesting an additional risk associated factor.

The higher CPI print for Q3 2017 is above the BoE’s 2.7% forecast, with the clear risk that the Q4 CPI print will be above the BoE’s 3.1% forecast for the quarter. The key uncertainty for the BoE is that given that there is limited spare capacity in the UK (with productivity growth remaining weak), the current moderate rate of growth is likely to be used up over the forecast horizon. The elephant in the room however remains Brexit, with a disorderly exit likely to cause an output shock.

The flattening of the Short Sterling interest rate curve suggests that despite BoE rhetoric over the potential of a rate increase, the market has discounted the potential for a policy change. One potential factor that could change current market pricing (with the market only pricing in a 50% probability of rate increase by Aug-18) is if the split in the MPC vote moves to 6-3 (i.e. 3 members voting for a rate increase) against the current consensus of 7-2.

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