Bank of England Remains in Wait-and-See Mode

The Bank of England (BoE) left interest rates unchanged today at 5.00%. The decision was widely expected as rate cuts in February and April have been followed by rising uncertainty over the prospects for inflation. In their June meeting, one Monetary Policy Committee (MPC) member dissented and voted for an immediate rate cut, suggesting the rate cutting inertia in the U.K. was still intact. However, the minutes of the June meeting revealed that, while all but one member voted to keep rates unchanged, "[f]or some members, the news had been sufficient to consider whether an immediate rise in [the] Bank Rate was warranted."

Unlike the oil angst of its continental cousin, rising food prices are a major culprit in explaining the acceleration in U.K. total inflation. Food inflation in the U.K. is running at 7.9% y/y, with the 3-month annualized trend running even hotter at nearly 12%. Core inflation has remained very tame, in spite of broad-based pressures coming from import prices, producer prices, and - of course - energy prices. The MPC noted in June, however, that none of the factors likely to drive inflation in the near term - world prices for energy and food as well as domestic gas and electricity prices - can be influenced by a BoE rate hike. At this point, one of the main measures staying the MPC's hand is the fact that wages have not yet shown any signs of rising, keeping medium-term inflation prospects under control. The MPC will want to ensure the rate of inflation is falling before year end to avoid fanning these flames when major wage negotiations begin in the first quarter of next year.

The probability of a UK recession in the next year is a coin flip. 2nd quarter GDP looks likely to post a 0.5-1.0% m/m gain (SAAR) with the likelihood that growth will be even slower in the second half of the year. The MPC would like to see a below-trend pace of economic growth in order to keep inflation and wage pressures in check. However, the BoE is still likely to lower interest rates before the end of this year in light of the ongoing decline in home prices, the likelihood of significantly weaker consumer spending, and the prospects that the easing global economic landscape will take the pressure off of commodity prices. We still look for one full percentage point in easing, though a bit later than we previously expected with the quarter-point cuts coming in October, January, March, and May. Another surge in oil prices could move the first cut out further but the MPC was comfortable with oil prices around $130 in June. The minutes for today's meeting to be released July 23rd will let us know if anyone's trigger finger at the MPC is getting itchy.

TD Bank Financial Group

The information contained in this report has been prepared for the information of our customers by TD Bank Financial Group. The information has been drawn from sources believed to be reliable, but the accuracy or completeness of the information is not guaranteed, nor in providing it does TD Bank Financial Group assume any responsibility or liability.