Bank of England goes large
Please note: The article does not constitute advice or any form of investment recommendation. All numbers quoted were sourced from Bloomberg data as at Thursday 4 November 2022. Past performance is never a guarantee of future performance.
In an echo of central bank activity across the Atlantic, the Bank of England yesterday hiked rates by 75 basis points (bp). In doing so, it achieved two milestones – the biggest rate hike in 33 years, and the highest base rate (now 3%) seen in 14 years.
As with the US Federal Reserve, (read our separate article Fed ups rates again), the BoE’s move was predictable. Tighter monetary policy is the main game in town right now, as global policymakers strain to bring inflation back under control. For the UK, the target is 2%, which for so long before 2022 had seemed impenetrable.
A 7-2 vote
While the Monetary Policy Committee (MPC) hike vote wasn’t unanimous, it was nonetheless convincing. Only two of the nine MPC voting members opted for a different course of action, with Swati Dhingra (50bp) and Silvana Tenreyro (25bp) dissenting.
The MPC is pursuing a front-loaded approach, with the MPC minutes declaring that the hike will: “reduce the risks of a more extended and costly tightening later1”.
Hiking rates again is further evidence of today’s tough domestic conditions, largely fuelled by strong international headwinds.
As BoE governor Andrew Bailey said in the post-MPC press conference: “If you compare this to the 1970s, and you compare this year to single years in the 1970s… this is a bigger shock than in any year in the 1970s2.”
With these vulnerabilities in mind, the central bank now sees less scope to hike rates too far, for fear of putting even further pressure on a creaking economy.
Different to the US
Yesterday’s decision appears to be the BoE’s most significant attempt to push back against the peak rate implied by the market. In the minutes, and during the press conference, the central bank re-iterated numerous times that the terminal base rate implied by the market is too high.
The minutes quoted: “The majority of the Committee judges that, should the economy evolve broadly in line with the latest Monetary Policy Report projections, further increases in Bank Rate may be required for a sustainable return of inflation to target, albeit to a peak lower than priced into financial markets1.”
During the press conference, BoE governor Andrew Bailey repeated: “We think bank rate will have to go up less than what’s currently priced into financial markets.”
Interestingly, this is contrary to events playing out in the US, where the market is thought to have underestimated both the potential peak rate, as well as the potential duration of higher rates.
Peak in view?
In response to Rishi Sunak’s government coming in and abandoning the fiscal spending plans of his predecessor, the rate market adjusted down the UK’s peak inflation rate in September 2023 to 4.7%, from 5.5% a month ago.
But with core inflation at 6.5% and trending upwards, the BoE noted that, at least at this stage, the risk remains that the central bank may have to react if it does not retreat. Indeed, the central bank’s projection points to a 5.5% inflation rate by end of next year.
At the same time, the clouds on the growth front are visible. The BoE sees a rise of unemployment to above 6% and a prolonged (albeit relatively shallow) recession in 2023. A peak rate at 3.5% seems a minimum, with a possibility to see additional hikes towards 4% should inflation not retreat at the expected pace.
We’ll be releasing our Outlook 2023 report on the 14 November which will include a UK-focused chapter. In the meantime, winter is coming and UK households are about to feel the chill.
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