The Bank of England’s Inflation Tussle

If you consider the recent economic data emerging from the UK you will soon form a picture of a fragile economy. The all too familiar disconnect between a robust labour market, lagging wages and inflation will prove to be the defining battle in this uncharted war of easy monetary policy.

Consumer confidence has declined to levels last seen in the wake of the Brexit vote, while growth forecasts have halved. Additionally, Brexit’s path has proved to be more problematic than the BOE has originally predicted. Thus, the bank may revise growth expectations in this week’s meeting from 1.9% to about 1.6%.

Meanwhile, inflation has overshot forecasts made at the beginning of the year. In June’s meeting, the bank noted that inflation could topple 3%. Since then, inflation has come in line with previous expectations of 2.6%. The central bank will likely raise rates at a faster pace than previously thought, further cutting inflation expectations.

I don’t see any more members crossing over to the hawkish side in today’s meeting however, with lagging economic data driving the neutral/dovish tilt.

Today, the initial jolt in markets will be dictated by the vote split. If we do see a 6-2 vote Sterling could dip lower.

Mark Carney’s speech will once again be essential to the pound’s value. If the governor’s hints at a rate rise before the end of 2017 we could see the pound rise.

Labour market growth is the real surprise for the BOE. Unemployment has fallen by more than expected which suggests less slack in the economy. At 4.5% unemployment, the labour market could withstand tighter monetary policy.

However, like so many other developed economies navigating their way out of easy money programmes, the UK’s wages remain weak. Excluding bonuses, wages were 2% higher over the three months to May compared to the same period in 2016 – lower than inflation.