Bank of England: Modest insurance tightening path – Deutsche Bank

Deutsche Bank Research’s UK economists Sanjay Raja and Maui Brennan have shifted their BoE base case from no hikes to two 25bp moves, in November and February. They argue Bank Rate is already restrictive, inflation is largely energy-driven, and second‑round effects remain limited. As long as the energy shock persists, they expect only modest ‘insurance’ tightening rather than an aggressive cycle.

Bank Rate seen as already restrictive

"We officially changed our call for the BoE. Following the September decision, we shifted our baseline from no hikes to two quarter-point rate hikes (one in November and another in February)."

"Acknowledging the above, we do not think that the current inflation wave, as we see it, will push the MPC into an aggressive tightening cycle. For us, the MPC’s reaction function may be more consistent with a modest tightening cycle – akin to two (and no more than three) quarter-point insurance rate hikes (should energy prices follow their expected market expectations). Why do we see modest insurance-style rate hikes as our basecase?"

"The BoE has room to manoeuvre. Almost all the centrist MPC members think Bank Rate sits above their loose judgements of neutral (3-3.5%). With Bank Rate at 3.75%, Bank Rate in their eyes is already restrictive (unlike, say, the ECB which has only just taken rates to the very top end of its neutral rate range). Put simply, a slow easing cycle over the last two years has given the MPC more space to operate in the current inflationary wave with restrictive policy already leaning on inflationary pressures."

"Policy rules suggest only a modest tightening. Our Taylor Rule estimates (contemporaneous, forward-looking and first difference) point to somewhat higher estimated policy rates, lying only a bit above 4%. These changes reflect higher-than-expected outturns in GDP and a firmer outlook for inflation. However, these mechanical rules imply only a modest increase in Bank Rate - a far cry from the aggressive hiking cycle experienced in 2022."

"So, what’s changed? The MPC’s patience around the unfolding energy shock. The longer CPI tracks at uncomfortably high rates, the higher the likelihood that second-round effects build. Put simply, we think the MPC may embark on a modest tightening cycle as an insurance policy against second-round effects. That said, should we see a rapid repricing in energy markets to lower energy prices in the coming weeks, the case for hikes may start to weaken."

(This article was created with the help of an Artificial Intelligence tool and reviewed by an editor. Know more.)