–Some Analysts Bringing Forward Rate Hike Calls After Letter

LONDON (MNI) – The open letter from Bank of England Governor Mervyn
King Tuesday revealed the upcoming February Inflation Report will
effectively endorse market rate hike expectations, leading some analysts
to rethink their own rate calls.

There has been a schism recently between market rate expectations
and many analysts’ forecasts, with markets largely pricing in a May hike
in Bank Rate while many economists have predicted no hike until the
fourth quarter. King’s letter appears to swing the debate in favour of
market expectations and the early hike scenario.

In a key passage the letter stated “The MPC’s central judgement,
under the assumption that Bank Rate increases in line with market
expectations, remains that … inflation will fall back so that it is
about as likely to be above the target as below it two to three years’
ahead.”

In other words, inflation is broadly on track to hit the 2.0%
target set for the BOE’s Monetary Policy Committee – but only if Bank
Rate moves up as the markets have been predicting.

Economists at Nomura brought forward their call for the first rate
hike from August to May.

Philip Rush, economist at Nomura, points out that the Inflation
Report’s market rate forecast is conditioned on interest expectations
over a 15 working day period running up to the completion of the report.

While in recent days market expectations, based on SONIA (sterling
overnight index average), have shown expectations of a May hike, over
the 15-day period they were putting a near 100% probability on a May
move. Over that period, as well, they were assuming Bank Rate would rise
from its current 50 basis point level to 125 bps by year end.

“The Governor’s letter seems to endorse market pricing for the MPC
to hike soon,” Citi economist Michael Saunders noted.

Simon Hayes, economist at Barclays Capital, is another who thought
the letter made an early rate hike more likely.

“Today’s letter implies that the MPC is a little more impatient to
raise rates than our current forecast of the first rate hike in November
suggests,” Hayes stated.

The reference in King’s letter to the equal likelihood of inflation
being above or below target is seen by analysts as a reference to one of
the Inflation Report’s key projections.

This is not the modal forecast, which underpins the fan charts the
BOE enlarges for media attention, but rather a “ribbon chart” buried in
the report.

Rush says that given the upside skew to the inflation projections,
the modal forecast could still show inflation on market rate
expectations coming in below target at the end of the forecast horizon –
the two to three year period.

King and his MPC colleagues have, however, highlighted the
importance to their thinking of the likelihood of inflation being on
target.

When the Inflation Report is published Wednesday, even if the
headlines talk about inflation falling back below target the detail
looks set to back markets’ rate views.

–London Bureau; Tel: +44207 862 7491 email: drobinson@marketnews.com

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