A consensus seems to be forming that the BOE could raise rates as early as this year.
This expectation would weigh on UK stocks, but could substantially support the pound. A good part of this has to do with the shift in rhetoric from the BOE and other British economic officials.
Until recently, the BOE, like most central banks, has been focusing on getting employment back to normal. In fact, the unemployment figures have been substantially positive in the last few months.
Tomorrow we get the latest unemployment data, and the consensus of expectations is for another set of good news. This could cement the idea that the employment situation has recovered.
And now the BOE must turn its attention toward inflation. The bank will be under increasing pressure to hike rates with CPI above target and rising, plus additional pressure from increasing jobs numbers.
What about asset purchases?
The overall expectation for central bank policy is that they would first stop buying assets, an “extraordinary” policy measure for them, and then they would proceed to raise rates.
However, asset purchases are generally designed to inject liquidity into the markets but have less of an impact on inflation. If the central bank is anxious about inflation, the best mechanism they have for combatting it is raising rates.
In this line of thought, earlier this morning UK Business Secretary Kwarteng said that the government should focus on higher wages and the BOE “will do a good job curbing inflation”.
This was after Governor Bailey said over the weekend that inflation would be above forecast. Crucially for the market, he said that he was “concerned” about inflation and that it was necessary to prevent inflation expectations from being embedded.
Expectations vs reality
Conventional wisdom among policymakers is that inflation expectations are a self-fulfilling prophecy. That is, if the markets expect inflation to rise, then market actors will start raising prices in anticipation. And this will effectively cause a rise in inflation.
Hence, central bankers feel they need to curb expectations ahead of time. Even if inflation isn’t really high, the important aspect for many is that they don’t presume inflation to remain high.
A “transitory” bout of inflation is acceptable to central bankers because it means that the market assumes that inflation will go down later.
This, in turn, will follow the same self-fulfilling prophecy. If the BOE is nervous that investors and businesses expect inflation to remain high for longer, they are more likely to take action.
What to look out for
If the employment data comes in at or above expectations, this would confirm the market’s view that the BOE will shift from worrying about employment to worrying about inflation. This will raise the chance of a rate hike sooner rather than later.
Analysts expect the claimant count rate to drop further by -46K, from -58.6K in the last reading. Remember, this is the number of people seeking unemployment, so a negative number here is positive.
Moreover, they anticipate that 243K people have found employment, compared to 183K in the prior month. Finally, the unemployment rate could tick down to 4.5%, from 4.6%.