BoE seen holding rates as energy shock fuels November hike bets

The focus this week is on energy costs rather than the rate decision itself. UK natural gas and Brent crude have surged nearly 20% this month amid the Iran conflict, the same factor that prompted the Fed to raise rates on Wednesday and has already influenced the ECB. This leaves sterling and UK rate markets more sensitive to oil and gas price movements than to Thursday's anticipated hold, since any further increase in energy expenses would bolster the argument for the November hike that markets currently assign an 80% probability to. Gilts carry a second, related concern: any hint that the BoE will reduce or stop its gilt sales would alleviate supply pressure at the long end of the curve, a situation Franklin Templeton is already positioning for with its "particularly attractive" assessment of the asset class.

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Info via Reuters.

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The BoE appears likely to keep rates unchanged on Thursday, but an Iran-driven energy shock has made markets far more confident of a November increase than economists are.

Summary:

• BoE decision due at noon UK time Thursday (11:00 GMT, 7:00am ET); Bank Rate expected to hold at 3.75%
• A Reuters poll found only three of nine MPC members seen voting for a hike this week
• Markets price an 80% chance of a November hike, versus about one in eight economists polled by Reuters
• UK natural gas and Brent crude have jumped almost 20% this month on the Iran war, the same driver behind Wednesday's Fed hike
• UK inflation was 3.1% in August, already above the BoE's 2% target; J.P. Morgan's Allan Monks sees it peaking at 3.9% in February
• The BoE will also update its gilt sales plans Thursday, with reports it may halt sales of 20 and 30 year gilts or exit secondary market sales altogether

The Bank of England is set to keep Bank Rate at 3.75% when it announces its decision at noon UK time on Thursday, 11:00 GMT, 7:00am US Eastern time, yet investors are closely watching for any indication that a Middle East-driven surge in energy costs could prompt the Monetary Policy Committee to move toward a hike sooner than anticipated.

A Reuters poll conducted last week showed that most economists expect the BoE to maintain rates for the remainder of the year, with only three of the nine MPC members anticipated to vote for a hike this week. Financial markets hold a different view. By Wednesday, they were pricing an 80% likelihood of a quarter-point increase in November, the first of roughly four hikes investors foresee over the next year. Economists remain considerably less convinced, with just around one in eight of those surveyed by Reuters expecting a November move.

The divergence between market pricing and economist projections stems from energy prices. British natural gas and Brent crude futures have risen by almost 20% this month, a climb linked to the Iran-related conflict that has already led the European Central Bank and the Federal Reserve to raise rates, with the Fed hiking on Wednesday and indicating further increases ahead. Higher energy costs heighten the risk that UK inflation, already at 3.1% in August, will move even further above the BoE's 2% target, a goal the central bank has missed in all but three months of the past five years.

J.P. Morgan economist Allan Monks said the BoE is likely to remain on hold this week to avoid fueling market expectations of a rapid tightening cycle, but still expects a hike in November, contending that there is a strong rationale for the Bank not to delay any further given that energy price movements point to inflation peaking at 3.9% in February. Others are less persuaded. Analysts at Evercore ISI noted that the gap between market pricing and policymaker expectations is nowhere more pronounced than in the UK, with rates markets pricing in roughly four and a half hikes over the next year while Bank leadership still aims to avoid raising rates altogether. Governor Andrew Bailey told reporters at the BoE's last meeting not to interpret its stance as moving toward a hike, and asset manager Franklin Templeton said this week that gilts look especially attractive on the view that a cooling labour market and softer economic outlook suggest looser policy than markets are pricing.

Beyond the rate decision, gilt investors are looking to the BoE's annual update on its balance sheet reduction plans. The Telegraph reported this week that the central bank will cease selling 20 and 30 year gilts, which have been hard hit by a global bond selloff, a step that could provide finance minister John Healey more fiscal flexibility ahead of his first budget statement on October 28. The BoE could go further and suspend secondary market gilt sales entirely, transferring that supply to the government's Debt Management Office instead, according to the same report. RBC strategist Peter Schaffrik said that would make the DMO the sole provider of gilts to the market, granting it full control over the issuance strategy.

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Note, no press conference today: