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Markets see +100% Probability of February Bank of England Rate Hike

Bank of England night

Image source: Bank of England. Credit Laura Bell.

Despite coming in for some criticism, Bank of England Governor Andrew Bailey might be pleased with his recent work: he has pushed back expectations for a rate hike to February.

Economists who were wrong footed by the Bank's decision to keep interest rates unchanged in November have accused the Governor of poor communication skills, arguing his previous commentary had lead them to believe a November hike was likely.

"Some degree of clarity in its communication to the public is essential," says Stefan Koopman, Senior Macro Strategist at Rabobank. "A large part of monetary policy deals with managing expectations, and this requires either pushing back or adding some nuance when speeches or comments are being widely misinterpreted."

The Bank has brought back to life its Carney-era moniker of the "unreliable boyfriend" by signalling a 2021 rate hike but then pulling the rug: at one stage in October Overnight Index Swap (OIS) markets were indicating investors were priced for a November move at 100% certainty.

Odds for a November rate hike faded as the month of November came around, but only for expectations for a December hike to rise.

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A look at the OIS market in the wake of the Thursday decision shows expectations are now firmly centred on February as the likely date for a rate hike.

On the eve of the policy update the market had priced a 62% chance of a December rate hike (remember a significant degree of 2021 hike pricing also came courtesy of a 55% chance of a Nov. rate hike).

But fast forward a day and the December 16 meeting is now only priced at 46%.

Odds of a February 03 hike are now however at 126%, up from 94% previously.

This pricing will be in line with the Bank's intention to assess the state of the labour market following the ending of the government's job support scheme.

By December the first official data covering the post-furlough period will be in, but by February a firm conclusion will be possible.

"We are again genuinely torn between two options: a December and February hike," says Robert Wood, UK Economist at Bank of America.

Expectations for rate hike path

Image courtesy of Oxford Economics

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The Bank was at pains to point out on Thursday that the market was expecting too much by way of rate hikes as the market had priced the Bank Rate at 1.0% by September 2022.

This has now fallen somewhat to just below 1.0%, but this level could yet still prove elevated by the Bank's own expectations.

"We expected the BoE's forecasts to signal fewer hikes than the market had been pricing," says Wood.

Wood says the Bank "was dovish, period" in its Thursday guidance, "after walking the market up the hill with strong hawkish communications since their September meeting ('this is another such signal that we will need to act') the Bank of England declined to increase interest rates".

Bank of America expects the Bank to pivot the debate away from 'we need to hike because inflation is well above 2%' - an argument that leads to a need to hike every quarter - to 'we need to gradually remove stimulus'.

Regarding whether a December or February hike is likely, Wood says December is definitely live.

"We would after recent communication put less weight on Governor Bailey today leaving plenty of room for interpretation about when 'coming months' might be. But we would focus on the broad dovishness," he says.

Nevertheless, Bank of America will shift their call to a 15bp hike in February, 25bp in May and they expect quantitative easing to be reversed in the summer.

"We continue to expect a third hike in February 2023. The risk to our call is that the BoE hikes in December. Either way we now no longer see two quickfire hikes, so either way see Bank rate at 25bp in February rather than 50bp before," says Wood.