The BoE’s May Quarterly Inflation Report is dovish adding further uncertainty to the start of the policy normalisation process. While the BoE is comfortable with rate rises broadly in line with market expectations, the bias is for these to be pushed further into the latter half of 2016.
Forecasts for growth have been cut for the next three years until 2017, while the outlook for inflation has been lowered for the first half of the 3-year forecast period. What is clear is that uncertainty over the evolution of inflation, wages and productivity make it difficult for the BoE to provide clear signals on the rate outlook beyond supporting current market pricing.
We are likely to see the BoE remain on a ‘watching and waiting’ mode at least until Q4 2015, by which time the BoE will have greater clarity on the path of inflation and any new possible fiscal measures. But beyond the economic/inflation outlook we would also argue that the BoE will be interested to see how asset markets react to the possible liftoff from the Fed this year.
The monetary experiment during the GFC has seen policy rates close to the zero lower bound and balance sheets elevated creating uncertainty over how financial markets and economic agents will react to:
1) the initial rate hike and
2) the subsequent mix of rate hikes and balance sheet reduction.
This is the real challenge for both the BoE and the Fed.
