• The Bank of England (BoE) held its policy steady in February. The key interest rate was maintained at 0.5% and there were no changes to the asset purchase programme.
• The economy is now forecast to grow 1.8% this year, an upward revision from 1.6% forecast in November. Growth-which is meagre by historical standards-is still judged to be above trend so the BoE are increasingly nervous that inflation will not return to target.
• As a result there was a clear signal that the Bank judges it appropriate to increase the interest rate both sooner and by more than the market had priced. Prior to the meeting the market was expecting only 75 basis points (bps) of further hikes between now and 2020. A 25bps rate hike now looks likely in May.
EXHIBIT 1: Bank of England GDP and inflation forecasts
Growth revised up but thanks to strength elsewhere The BoE upgraded its forecast for the UK economy marginally in its latest set of projections. It now expects annual GDP growth to be steady at 1.8% (see table for full set of BoE growth and inflation forecasts). The upgrade was largely due to the strength in activity elsewhere in the world. It was noted that global growth is now at the strongest pace in seven years and this is supporting UK activity. Half of all the growth registered in 2017 was due to net trade. Consumer spending is still expected to remain relatively subdued and investment modest whilst Brexit uncertainty continues. In other words, though growth might be better, for the average UK household, it might not feel like it.
The Committee also conducted its annual review of the supply side of the economy and concluded that potential growth is a meagre 1.5%. This is well shy of the potential rate of growth pre-crisis which was well north of 2%.
Putting it together-stronger demand and weaker supply means there are more inflationary pressures in the economy. Coupled with higher oil prices keeping inflation elevated near term, the Bank are clearly increasingly uncomfortable about inflation remaining above its target. The two hikes by the end of 2020 that the market had priced prior to the November inflation report were now not deemed by the Committee to be likely to be sufficient to bring inflation back to target. Policy would now need to be tightened “somewhat earlier and by a somewhat greater extent” than had been priced in November.
As a result, if events unfold as the Monetary Policy Committee currently project-growth of 0.4% quarter on quarter in Q1 and ongoing progress in the Brexit negotiations-then we should expect a 25bps hike in May and another 25bps before the end of the year. The Governor was keen however to temper expectations, reinforcing the message that the peak of rates is still expected to be well below the 5% we had been used to before the crisis.
The hawkish signal from the BoE boosted sterling and government bond yields. In the immediate aftermath sterling had appreciated by around 1% against both the dollar and the euro. The 2-year and 10-year government bond yields also rose. There was little impact on UK stocks relative to other international bourses. As the market digests these signals it is possible that the Bank is interpreted as less willing to look through elevated inflation. This could be perceived as troubling for the domestic economy, which may in turn impact domestically focused stocks.
Published by J.P.Morgan Assett Management
Author: Karen Ward. Chief Market Strategist, UK & Europe
The Market Insights program provides comprehensive data and commentary on global markets without reference to products. Designed as a tool to help clients understand the markets and support investment decision-making, the program explores the implications of current economic data and changing market conditions.
For the purposes of MiFID II, the JPM Market Insights and Portfolio Insights programmes are marketing communications and are not in scope for any MiFID II / MiFIR requirements specifically related to investment research. Furthermore, the J.P. Morgan Asset Management Market Insights and Portfolio Insights programmes, as non-independent research, have not been prepared in accordance with legal requirements designed to promote the independence of investment research, nor are they subject to any prohibition on dealing ahead of the dissemination of investment research.
This document is a general communication being provided for informational purposes only. It is educational in nature and not designed to be taken as advice or a recommendation for any specific investment product, strategy, plan feature or other purpose in any jurisdiction, nor is it a commitment from J.P. Morgan Asset Management or any of its subsidiaries to participate in any of the transactions mentioned herein. Any examples used are generic, hypothetical and for illustration purposes only. This material does not contain sufficient information to support an investment decision and it should not be relied upon by you in evaluating the merits of investing in any securities or products. In addition, users should make an independent assessment of the legal, regulatory, tax, credit, and accounting implications and determine, together with their own professional advisers, if any investment mentioned herein is believed to be suitable to their personal goals. Investors should ensure that they obtain all available relevant information before making any investment. Any forecasts, figures, opinions or investment techniques and strategies set out are for information purposes only, based on certain assumptions and current market conditions and are subject to change without prior notice. All information presented herein is considered to be accurate at the time of production, but no warranty of accuracy is given and no liability in respect of any error or omission is accepted. It should be noted that investment involves risks, the value of investments and the income from them may fluctuate in accordance with market conditions and taxation agreements and investors may not get back the full amount invested. Both past performance and yields are not a reliable indicator of current and future results.
J.P. Morgan Asset Management is the brand for the asset management business of JPMorgan Chase & Co. and its affiliates worldwide. This communication is issued by the following entities: in the United Kingdom by JPMorgan Asset Management (UK) Limited, which is authorized and regulated by the Financial Conduct Authority; in other European jurisdictions by JPMorgan Asset Management (Europe) S.à r.l.; in Hong Kong by JF Asset Management Limited, or JPMorgan Funds (Asia) Limited, or JPMorgan Asset Management Real Assets (Asia) Limited; in Singapore by JPMorgan Asset Management (Singapore) Limited (Co. Reg. No. 197601586K), or JPMorgan Asset Management Real Assets (Singapore) Pte Ltd (Co. Reg. No. 201120355E); in Taiwan by JPMorgan Asset Management (Taiwan) Limited; in Japan by JPMorgan Asset Management (Japan) Limited which is a member of the Investment Trusts Association, Japan, the Japan Investment Advisers Association, Type II Financial Instruments Firms Association and the Japan Securities Dealers Association and is regulated by the Financial Services Agency (registration number “Kanto Local Finance Bureau (Financial Instruments Firm) No. 330”); in Korea by JPMorgan Asset Management (Korea) Company Limited; in Australia to wholesale clients only as defined in section 761A and 761G of the Corporations Act 2001 (Cth) by JPMorgan Asset Management (Australia) Limited (ABN 55143832080) (AFSL 376919); in Brazil by Banco J.P. Morgan S.A.; in Canada for institutional clients’ use only by JPMorgan Asset Management (Canada) Inc., and in the United States by JPMorgan Distribution Services Inc. and J.P. Morgan Institutional Investments, Inc., both members of FINRA/SIPC.; and J.P. Morgan Investment Management Inc.
In APAC, distribution is for Hong Kong, Taiwan, Japan and Singapore. For all other countries in APAC, to intended recipients only.
Copyright 2018 JPMorgan Chase & Co. All rights reserved.