At the end of last year, most investors expected the Bank of England (BoE) to leave rates unchanged for most of 2020, subject to the economic conditions. After all, in December we received clarity that the Tories had secured a strong mandate to deliver on their Brexit vision. Whilst the future relationship between the UK and EU remains uncertain, the strong rejection of the nationalisation agenda by the opposition party may have encouraged capital expenditure. Shortly after the election, Chancellor Javid announced that BoE Governor Carney would be replaced by Andrew Bailey in March. The fading of some of the headwinds, including a phase one agreement between the US and China, reinforced the view coming into this year that rates would remain on hold. However, these views were not unanimous, as two members of the nine strong Monetary Policy Committee (MPC), voted to cut rates at their December meeting.
The view that rates would remain unchanged shifted materially this week as a sequence of weaker economic data releases questioned the resilience of the UK economy. Both Industrial and Manufacturing production proved to be much weaker than anticipated; the UK is indicated to have contracted by -0.3% in November. Price pressures also moderated more than expected with the Consumer Price Index rising only 1.3% over 2019 versus expectations of 1.5%. It is of concern that core inflationary pressures missed expectations of 1.7% and only printed at 1.4%. Leisure activities and retailers appeared to be discounting quite heavily to lure customers with little success, suggesting that consumers were unwilling to fork out over the holiday season in light of concerns surrounding the elections and the lingering doubts on path of Brexit. These fears were validated this morning when retail sales fell in the month of December, versus a pick up that was anticipated. Over the year, retail sales (excluding fuel) only grew 0.7% versus expectations of 3%. MPC member, Gertjan Vlieghe, indicated that he would vote to cut rates later this month adding to some of the more dovish noises coming from other BoE policy makers.
Given the persistence of economic disappointments, it is now much more likely that the BoE would vote to cut rates before the new Governor takes over. The futures market is now pricing in an above 70% chance of a rate cut on the 30th of January and gilt yields have fallen considerably this year reflecting this change. The release of employment data next week will probably be the deciding factor on whether the central bank decides to cut rates. While they may tolerate some weakness given the heightened level of uncertainty over the past two months, should employment prospects deteriorate they would want to act swiftly.
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