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Pound Slides After BOE Keeps Rates Unchanged, Warns "Little Closer" To Limits Of Inflation Tolerance

The Bank of England kept its key interest rate at 0.25%, gilt purchase program at GBP435BN, and corporate-bond plan at GBP10b, voting 9-0 on all 3 decisions. The BOE also raises growth forecasts, while keeping its inflation forecasts broadly unchanged, and said the current policy stance “depended on the trade-off between above-target inflation and slack in the economy.” The central banks also reiterated that “monetary policy could respond, in either direction, to changes in the economic outlook as they unfolded”

From the BOE statement:

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 1 February 2017, the Committee voted unanimously to maintain Bank Rate at 0.25%.  The Committee voted unanimously to continue with the programme of sterling non-financial investment-grade corporate bond purchases, financed by the issuance of central bank reserves, totalling up to £10 billion.  The Committee also voted unanimously to maintain the stock of UK government bond purchases, financed by the issuance of central bank reserves, at £435 billion.


As the MPC had observed at the time of the UK’s referendum on membership of the EU, the appropriate path for monetary policy depends on the evolution of demand, potential supply, the exchange rate, and therefore inflation.  The Committee’s latest economic projections are contained in the February Inflation Report.  The MPC has increased its central expectation for growth in 2017 to 2.0% and expects growth of 1.6% in 2018 and 1.7% in 2019.  The upgraded outlook over the forecast period reflects the fiscal stimulus announced in the Chancellor’s Autumn Statement, firmer momentum in global activity, higher global equity prices and more supportive credit conditions, particularly for households.  Domestic demand has been stronger than expected over the past few months, and there have been relatively few signs of the slowdown in consumer spending that the Committee had anticipated following the referendum.  Nevertheless, continued moderation in pay growth and higher import prices following sterling’s depreciation are likely to mean materially weaker household real income growth over the coming few years.  As a consequence, real consumer spending is likely to slow.

However, while cable initially spiked on the modestly hawkish announcement, it subsequently tumbled after the BOE warned that it has limited tolerance to above-target CPI, and some Monetary Policy Committee members had moved closer to those limits, explicitly noting that there are “limits to the extent above-target inflation can be tolerated.”

As the Committee has previously noted, however, there are limits to the extent that above-target inflation can be tolerated.  The continuing suitability of the current policy stance depends on the trade-off between above-target inflation and slack in the economy. The projections described in the Inflation Report depend in good part on three main judgements:  that the lower level of sterling continues to boost consumer prices broadly as expected, and without adverse consequences for expectations of inflation further ahead;  that regular pay growth does indeed remain modest, consistent with the Committee’s updated assessment of the remaining degree of slack in the labour market;  and that the hitherto resilient rates of household spending growth slow as real income gains weaken. In judging the appropriate policy stance, the Committee will be monitoring closely the incoming evidence regarding these and other factors.  For instance, if spending growth slows more abruptly than expected, there is scope for monetary policy to be loosened. If, on the other hand, pay growth picks up by more than anticipated, monetary policy may need to be tightened to a greater degree than the gently rising path implied by market yields.  Monetary policy can respond, in either direction, to changes to the economic outlook as they unfold to ensure a sustainable return of inflation to the 2% target.

Additionally, in its inflation report published concurrently, the BOE noted that household saving in the UK is set to fall to its lowest level since at least the early 1960s, according to new forecasts, boosting economic growth and taking some members of the Monetary Policy Committee closer to the limits of their tolerance for above target inflation. But, for now, the committee has voted unanimously to keep policy on hold.

As the FT adds, the bank’s new forecast, published on Thursday, is for growth of 2 per cent this year, well above the 1.4 per cent forecast they made in November. Consumers are expected to save less to support higher spending than the bank had expected. Over the next few years, the additional government spending that was announced at the end of November, stronger growth in the US and the Euro area and a further easing of credit conditions are expected to provide a further boost.

The bank’s forecast now implies the economy will be 1.5 per cent smaller in three years’ time than they expected before the UK voted for Brexit in June. This is significantly smaller than 2.5 per cent reduction they projected in November.

For now, the pound is taking the announcement as less hawkish, and after USDGBP spiked at high as 1.27, it has since tumbled to session lows just above 1.26.

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