A dove among the hawks?

Bank of England Governor Andrew Bailey provided further evidence of his dovish leanings in a speech given at Brunswick Group's Cost of Living Conference on 1 March. His stance appears to be at odds with the more hawkish rhetoric coming from the other major central banks. While both the Federal Reserve (Fed) and the European Central Bank have explicitly stated that there will be further hikes to come, Bailey has remained non-committal on this point, stating that further rates rises were not inevitable.

Rate expectations have increased over the past month

Since the start of February, investors have ramped up their expectations for further central bank rate hikes. This has been driven by a global economy that appears to be experiencing something of a re-acceleration, which in turn is expected to keep inflation higher for longer than previously expected. 

This has been backed up by a strong US jobs reports for January¹ and higher-than-expected US CPI numbers². While the debate at the start of the year was all about whether the Fed would be able to engineer a ‘soft landing’ or a ‘hard landing’ (ie, whether rate hikes would lead to an economic recession), the narrative now seems to have switched to a ‘no landing’. In this scenario, the US economy does not slow down, but inflation remains elevated.

UK data has also proved to be stronger than feared. On this basis, markets were probably expecting Bailey to provide a recognition of the improved economic outlook and give a steer that further tightening might be needed. That we did not get this has reinforced my view that the BoE is staying more dovish compared to the other major central banks. 

UK housing market

What are the reasons behind this divergence in central bank policy and Bailey’s apparent reticence to push for further rate hikes? I believe a key factor is concerns over the UK economy’s outsized exposure to the housing market. Specifically, the BoE will be acutely aware that a significant number of UK householders will need to refinance their mortgages over the next year or so at much higher rates.

While US householders are better insulated from the impact of higher rates given the prevalence of long-term fixed mortgages, this is not the case in the UK where mortgage deals are typically short term. Although UK mortgage rates have ticked down from their peaks of last year, they remain well above recent levels and householders are likely to feel the pain as they switch to more expensive deals (Figure 1). 

This has obvious knock-on economic consequences and probably explains in large part why the BoE appears reluctant to tighten too much. I understand why policymakers are being cautious, although with UK CPI still running above 10%, I think this dovishness also increases the risk that UK inflation stays higher for longer than elsewhere. In the months ahead, the BoE could therefore face a difficult balancing act as it attempts to quell inflationary pressures, but without causing too much damage to consumer confidence.

Figure 1. UK mortgage rates remain elevated

Source: M&G Bloomberg 2 March 2023

The value of investments will fluctuate, which will cause prices to fall as well as rise and you may not get back the original amount you invested. Past performance is not a guide to future performance. The views expressed in this document should not be taken as a recommendation, advice or forecast.

¹ Jobs report January 2023: Payrolls increased by 517,000, unemployment rate at 53-year low (cnbc.com)
² January CPI accelerates, but trend easing | Reuters