Instant View: Bank of England sounds inflation alarm, pauses gilt sales

LONDON, Sept 17 (Reuters) - The Bank of England predicted British inflation will top 4% early next year as it held interest rates unchanged on Thursday and tweaked its plans to run down its existing holdings of UK government bonds by halting sales to the market for now, which boosted gilt prices. 

The central bank said inflation risks had tilted further to the upside since publishing its last set of economic forecasts in July, adding that the move in energy prices since then bore similarities to its "adverse" scenario that risked entrenching inflation.

Governor Andrew Bailey warned explicitly that prolonged conflict in the Middle East may require tighter policy.

In a break from the past where it would actively sell gilts back to the market across a range of maturities, the BoE said it would hold gilts that mature before 2035 until they mature.

UK government bond prices rallied, which pushed down their yields, and in turn weighed on the pound, which fell 0.1% on the day to $1.3366.

COMMENTS: 

SIMON DANGOOR, DEPUTY CIO FIXED INCOME, GOLDMAN SACHS ASSET MANAGEMENT, LONDON:

"The MPC’s central block now flags upside inflation risks, but wants to see second-round effects before pulling the trigger. It is increasingly likely the broader market environment could force them to hike, however."

MOHIT KUMAR, CHIEF EUROPEAN ECONOMIST, JEFFERIES, LONDON:

"At the margin, reducing gilt sales and then abolishing totally for the long-end is absolutely a positive.

There were some expectations that the Bank of England would do it because with the Treasury issuing more gilts, the Bank of England's QT programme is directly competing for gilt sales.

So by doing this measure, they have effectively changed the supply, demand picture, particularly for longer-dated gilts. That's a positive and that's why gilts are liking it and the long-end is rallying." 

FELIX FEATHER, ECONOMIST, ABERDEEN, EDINBURGH:

"The Bank of England’s decision to hold rates steady at this meeting doesn’t come as any surprise to us. And the vote split of 6-3 was not as close as it might have been. The inflationary impulse from higher energy prices has deepened since the MPC last met in July, but no further members have come round to the hawks’ way of thinking as of yet.

However, the Bank could well be hiking at its next meeting in November.

The November meeting will see the Bank produce a full set of forecasts and hold a press conference, which would give it a better opportunity to explain a change of policy. So it is a natural starting point for a hiking cycle."

MADISON FALLER, GLOBAL INVESTMENT STRATEGIST, J.P. MORGAN PRIVATE BANK, LONDON: 

“Threadneedle Street was in full needle-threading mode today, and the hold was about managing risk while preserving credibility. The MPC had room to stay steady amid mixed labour momentum; growth that’s been resilient, but remains vulnerable, and still only limited signs of second-round inflation pressure. But with energy pressures proving persistent, the wait-and-see window may be narrowing, and today’s dissents signalled a hawkish tilt. If the BoE pivots to hikes like its central bank peers, the message will likely remain that any moves are data-contingent, not a commitment to a rapid, extended cycle.”

DAVID REES, HEAD OF GLOBAL ECONOMICS, SCHRODERS, LONDON:

"Domestically generated inflation is contained, wage growth is decelerating and unemployment near 5% points to meaningful slack in the labour market. This is not an economy crying out for higher rates.

"The bigger risk lies with fiscal policy. October’s Budget will be crucial. A spending splurge could revive domestic price pressures and bring forward rate hikes, but the strain already visible in gilt markets should make an inflationary fiscal expansion less likely. For now, the Bank has room to look through a temporary energy-led rise in headline inflation."

NEIL BIRRELL, CHIEF INVESTMENT OFFICER, PREMIER MILTON, LONDON:

"No change from the Bank of England on rates and we will now need to wait until after the Budget for their next decision. The Bank seems to be more relaxed on inflation risks than their international counterparts, although the markets are setting borrowing costs at present anyway. With the expectation being for a number of hikes through the end of this year in to middle of next, the gilt market may be more susceptible to a move the other way."

(Reporting by EMEA Markets Team; Compiled and edited by Amanda Cooper)