Shah on the Bank of England
The communication roadmap beyond a 7% threshold.
The BoE has used the minutes of the January meeting to communicate two important messages…
1) that it believes there to be more slack in the labour market than the unemployment rate would suggest, and
2) they will not raise rates when the unemployment hits the 7% threshold in the near future.
While a lowering of the unemployment threshold is possible the lack of discussion on this option in the minutes suggests to us that the BoE will continue to use communication to guide market expectations.
The minutes of the January BoE meeting show that the MPC wanted to communicate the message that there was no need to raise the Bank Rate even if the 7% unemployment threshold was hit in the near future. This goes beyond the usual stance that 7% is a “threshold not a trigger” with the minutes being used to provide the banks thinking going forward as opposed to explaining what happened at the latest meeting.
The BoE accepts that financial market expectations will remain tilted toward earlier rate hikes but are keen to dampen market pricing of the likely rate path.
Explicitly diluting the importance of the 7% threshold is not a surprise given the expectation that the 7% threshold will be hit in the near future. The BoE meeting was held before latest data showed unemployment falling to 7.1% in November from 7.4% in October (7.6% in September).
The 0.5% point fall in unemployment between Sept and Nov highlights the difficulty for the BoE in embracing a lower threshold for unemployment. We still think that the BoE will use communication as opposed to cut the unemployment threshold to 6.5% in order to strengthen its forward guidance. The communication process has already started with the BoE delving into an explanation as to why there is more slack in the labour market and thus the equilibrium unemployment rate is lower than they believed.
The BoE explains why pressure on pay growth would require a lower unemployment rate based on the view that:
1) the fall in unemployment had come from a fall in medium and long-term unemployed
2) an intensification of job search efforts as benefit requirements are tightened, and
3) a high proportion of part-time workers who would prefer to work full-time.
What is interesting is that the BoE has used the minutes to provide guidance on the policy outlook. The BoE accepts that financial market expectations will remain tilted toward earlier rate hikes but are keen to dampen market pricing of the likely rate path.
The BoE says that when it is time to raise rates it would be appropriate to do so “gradually”. This guidance on policy will become increasingly important especially as the BoE will likely follow the trend set by other central banks and rely on macroprudential measures to fine-tune policy toward the housing market. At the top of the list is to put an end to the governments Help to Buy scheme with the BoE already having taken its foot of the accelerator by ending support to the housing market via the FLS last year.
The next focus will be the February Quarterly Inflation Report on Feb 12 which will be used to expand upon the themes introduced in the January minutes. We remain biased toward seeing the money market curve steepen as the BoE struggles to dampen expectations of early tightening. We have been biased toward paying 12x24 GBP OIS from 0.98% and continue to see this trade back to 1.25/1.30%