Hawkish Message Concealed within Dovish Decision

Discussion and Analysis by Charles Porter:

This afternoon, the Bank of England’s Monetary Policy Committee published what at first sight appeared to be a Dovish decision. However, concealed amidst the interest rate and quantitative easing headlines were more Hawkish undertones. The market, to a significant extent, internalised these comments as a signal of an imminent, before-year-end, monetary policy tightening.

Inflation statistics released on Monday began to entice market sentiment in favour of a rate hike. However, at midday, the headline interest rate, the Bank Rate, was held at 0.25%. Accommodative monetary policy in the form of quantitative easing was also retained at £435bn. However, an actual rate hike was probably never a credible reality this time around. On the back of high inflation, the pound revalued strongly earlier this week despite the lack of hiking sentiment. Therefore, markets may reasonably have been anticipating a turn towards a future rate hike, rather than an actual stimulus reduction. In fact, if we regard futures markets, a divisive probability of a future hike sided with no immediate hike.

What would traditionally represent an accelerating probability of a rate hike in the future is a swing in the vote towards a hike. Because the Monetary Policy Committee comprises of nine members and the previous decision saw only two members vote in favour of a rate-hike, a division in excess of 7-2 would satisfy the expectations that markets priced in over the previous two days. However, Michael Saunders and Ian McCafferty remained the only two members of the Committee to vote in favour of a hike. This was in line with our expectations.

Alone, therefore, the composition of the decision and the lack of movement itself would have forced a selling off of Sterling because expectations were underwhelmed. The empirical reality of the event at midday today, however, was a strengthening of sterling across all major currencies. The driver of this move was a set of idiosyncratic comments contained within the minutes from the Committee’s meetings.

These minutes detailed two currency-appreciating statements. Perhaps the most significant of these two observations was the admonition that if inflation continues to surpass forecasts (as Monday’s announcement attested to) then “monetary policy could need to be tightened” sooner “than current market expectations”. This signals to all markets alike that they have undervalued the probability of UK monetary policy tightening, inducing a flow of capital into the Pound and thus an appreciation.

This movement was reinforced by a second, previous, statement within the Committee’s minutes. The conditional feature of the Committee’s admonition, cited above, was, if current above-forecast trends persist. The second statement lends support to this conditionality. Specifically, the minutes confessed that the Bank of England expects October’s CPI inflation figure to exceed 3%; a critical and exaggerated figure within the British Political Economy. The mandate of the Bank demands that if inflation, the central concern of monetary policy, moves more than 1 percentage point from the targeted 2%, the Bank must explain itself via letter to the Chancellor of the Exchequer.

Therefore, the verification of an antecedent to tightening and a normatively important price level movement install confidence within financial markets that future stimulus curtailment is a reality. The immediate aftermath of the Bank’s publications showed a strong appreciation of the Pound Sterling. Whilst the revaluation against the Euro was stronger than with respect to the Dollar, both immediate shifts were in excess of 1 percent. Gains continued throughout the afternoon, improving the position of individuals selling Sterling.