The Bank of England turns dovish in May and walks away

• The outlook for the interest rate path in the UK after May Inflation Report from the Bank of England sees even lower than 90% chance for the bank to move in November.
• The dovish turn of the bank is framed by lower inflation and growth forecast and shifting drivers from external to domestic factors.
• Any future rate hike will be “gradual and limited” as Brexit-related uncertainties weigh. 

With the UK inflation decelerating towards the target more quickly than expected in February and the GDP growth slowing down sharply at the beginning of this year, it was no surprise from the Bank of England to keep the Bank rate at the unchanged level of 0.50% in May.

Looking ahead, the bank of England sees the rate hike path in line with the market forecast that sees the 86% probability of the Bank of England moving in November, down from 86% anticipated ahead of May Inflation Report.

May Inflation report is a dovish turn from the Bank of England that tried to downplay the erratic effect of the economic slowdown at the beginning of this year, but still saying that inflation drivers will be increasingly on domestic side moving away from the effect of past Sterling depreciation. And this is what warrants only very gradual and limited path of interest rate hikes in the UK.

"The inflation rates of the most import‑intensive components of the CPI appear to have peaked,"
The Bank of England May Inflation Report says.

In line with what has become a new standard within the Monetary Policy Committee (MPC), there are seven doves voting in favor of the decision and two arch-hawks, Ian McCafferty and Michael Saunders voting in favor of 25 basis points rate hike in May.

May Inflation Report revised both inflation and short-term GDP growth forecast lower, saying it was driven by lowered expectations on domestic demand, but kept the forecast for 2019 and 2020 unchanged.

The unemployment forecast was revised down somewhat further and is now expected to level out at 4.0% in 2019.

The most important driver of the currency market was the dovish turn on inflation that is expected to stabilize at the target in 2020. The reason is that the bank anticipates that the effect from the past sterling weakness is fading faster than previously thought.
On UK Inflation:

"The MPC judges that the impact of the past depreciation of sterling on CPI inflation while remaining significant, is likely to fade a little faster than previously thought. Taking external and domestic influences together, CPI inflation is projected to fall back slightly more quickly than in February, reaching the target in two years."

In terms of the interest rate outlook, the dovish tone was underlined by the change in the wording of the statement removing the word "expected"  from the policy guidance saying it is likely to raise the Bank rate at a gradual pace and to a limited extent. 

So what is now projected by the bank of England is a” gently rising path for Bank Rate over the next three years."

As The Bank of England Governor Mark Carney explained during the press conference, that the UK households and business all expect the Bank rate to rise slightly in three-year time, but they all are more worried about the actual outcome of the Brexit negotiations as the future path for the policy rate will be up, with move only gradual and limited.

International comparison of GDP growth

Source: The Bank of England May Inflation Report