Bank of England review: Slightly dovish as inflation outlook is lowered

As expected, there was another 8-1 split vote on whether to keep the bank rate unchanged or raise it immediately. The MPC voted unanimously in favour of keeping the stock of purchased assets unchanged at GBP375bn. The minutes were slightly dovish as the BoE has lowered its inflation outlook and now expects CPI inflation to stay below 1% until spring next year. The lower inflation outlook is due to a combination of lower oil prices and stronger GBP which weigh on inflation through lower energy and import prices, respectively.

As the domestic cost pressure must offset the downward pressure stemming from external factors in order for the BoE to meet its 2% target, the BoE wants to see both core inflation and annual unit wage cost growth move higher. That said, there are still 'a range of views about the outlook for activity and inflation' and thus there are also disagreements between the eight MPC members not voting for an immediate hike.

The MPC members are so far not that worried about the economic slowdown in China and emerging markets and the impact on the UK but are monitoring the development. That said, the MPC still considers this a downside risk to the global economic outlook.

"The minutes support the view that the BoE's focus has shifted to inflation and that the BoE will not hike rates until CPI inflation has moved higher. We expect CPI inflation to remain close to 0% in coming months and one cannot rule out that inflation may turn negative. Most MPC members are not comfortable raising rates with higher uncertainty in the near-term. That said, we still expect BoE to hike in Q1 16, probably in February. CPI inflation is expected to pick up in January when the base effects from the oil price drop in H2 14 disappears. Also we are still positive on the UK and the economic upturn remains on track, in our view, with growth rates above or at trend (0.5% q/q)",says Danske Bank.

The unemployment rate is already more or less back to 'normal' and we think that the labour market will tighten further going forward which would lead to even higher wage growth. The minutes acknowledge that the labour market is tightening, e.g. it is stated that 'labour skill shortages had become increasingly widespread'.

"In the short term we expect weak inflation to support EUR/GBP and thus see little prospect of a change in trend for both EUR/GBP and GBP/USD. Over the medium term, we still look for a stronger GBP supported by higher UK interest rates following a BoE rate hike. We target EUR/GBP at 0.70 and GBP/USD at 1.57 in 6M", added Danske Bank.