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Bank of England May Need to Recondition Market Expectations

Don’t expect any fireworks from the Bank of
England (BOE) on November 5, say analysts at Barclays, although Governor Mark
Carney may have the tricky task of explaining to the market the MPC’s short-
and medium-term interest rate expectations.

The BoE will have its own Bonfire Night
party with the November interest rate decision, the minutes of the meeting and
the Inflation Report and press conference all released Thursday.

According to a note from Barclays, the
market has moved from pricing the first bank rate hike by May 2016 to Q2 17,
pushing out timing expectations from about seven months at the August Inflation
Report to about 17 months now.

“This is close to being as far out as the
rate tightening has been priced this year, the peak being in Q1 15 when
inflation first started falling sharply,” Barclays says.

Recent Q3 15 UK GDP data were weaker than
BoE staff downwardly revised forecasts in October while the services sector,
which makes up to close to three-quarters of the economy, is still showing
signs of a cyclical slowdown.

Barclays believes that near-term GDP and
inflation forecasts are both likely to be revised lower but of greater
importance is the market’s perception of how the MPC interprets inflationary
forces beyond the first year of the forecast.

“Governor Carney has stated there are
conflicting forces on medium-term inflation as stronger domestic inflation might
be more than offset by weaker external inflation,” Barclays’ analysts say. “October’s
minutes saw the MPC note that an increase in core inflation would be required
if the committee were to meet its objective of returning CPI sustainably to the
2% target within two years. The decline in the interest rate profile should go
some way towards supporting this return to target.”

Barclays highlights that Carney will have
to acknowledge the recent weakness in both growth and inflation and that he may
wish to begin to recondition market expectations – “either explicitly or
implicitly” – to reflect the fact that the committee remains likely to raise
rates over the forecast horizon.

“On the other hand, across the October
minutes, recent speeches and interviews, there has been no explicit attempt to
talk up prospects of rate tightening. However, implicit messages can come via
the MPC forecasts,” the note says 
       Twitter @Profit_and_Loss

Colin Lambert

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