News in Charts: Bank Overly Sanguine on UK Growth Outlook

Last Thursday, the MPC again voted 7–2 to keep Bank Rate on hold at 0.50%. Following recent remarks by Governor Carney, a ‘no change’ decision was widely expected by investors. As recently as one month ago, investors viewed the prospect of a rate hike by the end of this year as virtually certain. By close of business the day before the MPC vote, the chances had faded to just over 70%. Immediately following publication of last Thursday’s Inflation Report, market-implied odds fell to just over 60%.

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According to Thursday’s Inflation Report, the inflation outlook is more benign than it was at the time of the February Report, with the Committee revising down its central projection for the targeted measure in the final quarter of this year by 0.2 percentage points to 2.2%. From early next year risks around the target are seen as broadly balanced, with inflation about as likely to be above 2.0% as below. The Committee’s judgement is that the inflation outlook has changed not because the outlook for activity has deteriorated, but because the impact of sterling’s post-referendum depreciation is unwinding quicker than had been expected. Indeed, the Bank remains remarkably sanguine about the growth outlook.

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The MPC judges that the preliminary estimate of growth in the first quarter of this year is likely to be revised up by 0.2 percentage points to 0.3%, noting that early Q1 growth estimates tend to get revised up by more than early estimates of growth in other quarters. We concur, although find that this effect is not statistically significant. What the Inflation Report fails to mention is that growth revisions also tend to be pro-cyclical. If there are good reasons to believe that the economy is slowing — and there are many in our view — then it is quite likely that the initial estimate will get revised down. In a forthcoming ‘In Depth’ note for our clients, we shall elaborate on this point.

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Little attention is paid by the Committee to the Bank’s own Credit Conditions Survey. In Q1 of this year, the balance of lenders reporting tighter conditions on unsecured credit was the highest in the eleven-year history of the survey . A model that takes information from this survey into account would tell us that ‘true’ growth in Q1 might have been anywhere between +0.4% and -1.2%, with a central estimate of -0.4%.

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Back in November we described that month’s well-telegraphed hike as “nothing other than a reversal of the unnecessary, and quite probably ineffective, post-Brexit rate cut”. We felt that interest rates were on hold for the foreseeable future. Nothing has happened since then to cause us to change that view.

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Overall Fathom concurs with the market’s view that the euro area is unlikely to fall apart in the near future. Arguably, there is even some scope for upside risk if Germany and France make progress towards enhancing the durability of the currency bloc’s structural framework — a so-called ‘golden scenario’ for the euro area.