Bank of England seen holding rates as economy continues to outperform

Bank of England Governor Mark Carney
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Bank of England Governor Mark Carney

The Bank of England (BOE) is widely expected to leave interest rates on hold Thursday at a record low of 0.25 percent after the U.K. economy continued to trounce gloomy forecasts and delivered a strong finish into year end.

In light of the robust economic performance, which has consistently performed better than consensus expectations since the EU referendum in late June, the BOE is also seen raising its growth outlook for the U.K. The most recent figures, published in November's Quarterly Inflation Report, had forecast 1.4 percent growth for 2017, 1.5 percent for 2018 and 1.6 percent for 2019.

The central bank is also seen improving its unemployment outlook after the latest labour force data reflected unemployment hovering at an 11-year low of 4.8 percent with a gentle lift in wage growth to 2.8 percent by the end of 2016.

Pedestrians walk past the Bank of England (BOE) in the City of London, U.K.
Luke MacGregor | Bloomberg | Getty Images
Pedestrians walk past the Bank of England (BOE) in the City of London, U.K.

Less clear cut, however, is whether the BOE will simultaneously alter its inflation forecasts, the latest of which from last November predict that inflation is on track to hit 2.8 percent in 2017 before slipping to 2.7 percent in 2018 and 2.5 percent by the following year.

While the BOE's oil price forecast from last November is still largely in line with today's price of $56 per barrel of Brent crude, sterling has since strengthened a little, which is likely to be reflected in Thursday's forecasts, according to Kallum Pickering,the senior U.K. economist at Berenberg.

The currency strengthening also clouds the inflationary picture slightly, Pickering suggests.

"That the BoE will likely raise its sterling forecast implies less inflationary pressure through the exchange rate in the medium-term. However, stronger expected demand growth relative to potential supply growth will probably raise the BoE's assessment of underlying inflationary pressure," he posited.

Traders will also be interested to learn if there are any dissenting voices in this month's interest rate vote after the minutes released from the Monetary Policy Committee (MPC) meeting from last December showed voting policymakers in unanimous agreement to keep rates on hold.

Even if one or more bankers do take the opposing view to the majority, this should not be interpreted as signaling the beginning of a near-term upward trajectory for rates, says Laith Khalaf, senior analyst at Hargreaves Lansdown.

"The minutes of the MPC meeting will be pored over for any whiff of an interest rate rise, but the reality is that whether there's a hike this year or not, rates are set to remain low for some considerable time," he opined in an email to clients.

The BOE will indeed be cautious, agreed analysts at Societe Generale.

"The MPC will be prepared to tolerate a significant overshoot of inflation above target for as long as it remains on alert for a Brexit shock. It is likely to strengthen its anti-inflation rhetoric to reassure the markets, though," affirmed authors of a research note from 30 January.

Thursday's meeting is set to take place the day following the conclusion of the programme of gilt (U.K. government bonds) purchases which resumed following a vote to extend it last August.

Analysts at UBS say they expect the MPC to confirm that quantitative easing (QE) operations will cease once the already announced gilt and corporate bond programmes have reached their planned conclusions.

"As with past QE programs, we would envision the BoE to cease corporate purchases once the limit of £10 billion ($12.5 billion) is reached. At the current run rate, that leaves approximately four months. Of course, this could be extended should purchases slow," read UBS research dated issued on Monday.

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