There is an old English saying, that ‘a bird in the hand is worth two in the bush’, essentially referring to the value of something today relative to at some point in the future. This is very fitting in terms of the respective economic and monetary narratives of the Bank of England (BoE) and the Monetary Policy Committee (MPC) this week.

The BoE raised the Bank rate by 25bps to 0.50% and initiated the process of Quantitative Tightening (QT), by ceasing its reinvestments of maturing Quantitative Easing (QE) bond assets, both were expected by markets going into the event. However, the details of the BoE statement and the accompanying Monetary Policy Report (MPR) were perhaps more interesting.

First, the detail of the 25bps hike was interesting, in that the MPC were split 5:4, with 4 members choosing to dissent in favour of a 50bps hike. The narrative around future hikes in the statement remained relatively cautious, with the expression “further modest tightening likely in coming months”, a modest iteration from “over the forecast period”. Some commentators have viewed this as a modest hawkish iteration - bringing Bank rate hikes forward. However, the BoE inflation projection based on the market implied rate path shows rates significantly below target at the forecast horizon - an indication that the market may be pricing too much tightening from the BoE, given the current assumptions on growth.

However, it was really the BoE narrative around the growth and inflation trade-off that was most interesting. While the BoE expect Gross Domestic Product (GDP) to return to pre-pandemic levels in Q1 (it has already attained this target in the monthly data series), there was a far greater level of concern for the UK growth dynamic apparent in the press conference commentary. The BoE Governor was clear that the Bank had not raised rates because the economy was “roaring away”, rather that inflation may not return to target without it (thus potentially intensifying the consumer spending squeeze through yet higher price levels). Furthermore, he stated that it would be a clear mistake to extrapolate simplistically what the BoE had done at this meeting.

The BoE are acutely aware of the drop in post-tax labour income, likely placing significant pressure on households - especially at the low end of the spectrum; and in that basis, the Governor acknowledged that it was a hard message from the BoE (that the cost of money was essentially rising at the same time, or even as a function of rising bills and expenses - not to mention taxes - at the consumer level).

Essentially, the BoE made it clear that the tightening of policy was a direct response to the supply adjustment (both structural from Brexit related issues, and less so from Covid related global supply chain constraints), but that there were clear and obvious risks to the growth backdrop from doing so. Indeed, beyond the near-term reopening-led growth acceleration expected over coming months (leading to a higher 2022 growth forecast, growth is expected to moderate through H2 and into 2023. A complicated backdrop for the economy, the consumer, inflation, the BoE and GBP. In this regard, the BoE had clearly expressed a preference for rate hikes now, over later. A bird in the hand is perhaps more palatable than two in the bush!

If anything, the message from the European Central Bank (ECB) was the opposite.

The ECB statement outlined the (albeit declining) pace of QE asset purchases that encompasses a reduction back to the pre-Covid level of Asset Purchase Program (APP) purchases at EUR 20B per month from October 2022 onwards. This was seen initially as maintaining a dovish posture, as the ECB has often repeated that the sequencing of monetary policy would require purchases to end, some time before rates could rise. Indeed, the statement also explicitly stated the possibility of a resumption of buying under pandemic emergency purchase programme (PEPP) if needed, along with the standard pledge to keep rates at present, or lower until 2% inflation in sight.

And then came the press conference.

The ECB President expressed the Governing Council’s assessment that growth will likely remain subdued in Q1 (and perhaps beyond), as a function of the Omicron wave, price rises weighing on purchasing power and ongoing supply disruption (“bottlenecks will persist for some time”), reducing manufacturing output potential. However, the Governing Council expect the economy to pick up strongly through the year.

The statement that the Governing Council was unanimous in its concern about the inflation data was a hawkish iteration - the non-core majority had previously been much more cautious about the persistence of inflation (or its by-product, less policy accommodation). Furthermore, the ECB President made it clear that the outlook for inflation, and most pointedly, the assessment that rate hikes are “very unlikely in 2022” (as expressed at the December meeting), would be clarified at the March meeting, alongside the revised forecasts.

With inflation expected to fall back sharply (on German base effects) in January - which it failed to do - the ECB are reacting by highlighting the increased uncertainty, and at the same time buying time to assess the situation further. Essentially, the ECB have this week added flexibility and optionality on their monetary policy stance - above and beyond the time dependent path that was clearly laid out at the December meeting (and reiterated in the opening statement).

The BoE see growth slowing through the year as inflation, tax hikes, and higher rates dampen consumer demand, but feel that they need to tighten policy early in order to prevent the second round effects of inflation becoming engrained (as well as adjusting to the structural supply change). Similarly, it is not clear that the ECB has the capacity to hike in any meaningful sense without collapsing growth or exploding peripheral spreads. Especially as the ECB were clear that more than 50% of the inflation is (energy related) cost push not demand pull… hurting real incomes, as well as corporate and / or government balance sheets.

The ECB have chosen not to do anything now, but to increase their optionality to act in the future. The BoE have taken a bird in the hand, so to speak, whereas the ECB have bought an option on two at a later date!

We will assess the implications of these relative policy changes over the coming days. In the first instance it is a hawkish iteration from the ECB and dovish (relative to market pricing) from the BoE. But owning an option is not the same as exercising an option, for that only time (and inflation) will tell!