The Bank of England delivered on market expectations today, hiking rates by 50bps – the largest hike for the MPC since 1995. The MPC voted 8-1 in favour of the move, markets were expecting two dissenters so this can be seen as a marginally more hawkish move than expected and could signal more aggressive hikes in the future.
The caveat to this is that the BoE have become significantly more pessimistic about the state of the economy, predicting a recession that starts in Q4 this year and lasts through 2023. Not just a technical recession but a drop in output of 2.1, the worst performance for the economy since the global financial crash should it come to pass.
Not done with shocks, the bank also predicted a peak inflation print of over 13% and to remain elevated through much of 2023 – meaning the cost of living squeeze isn’t going away any time soon.
Unsurprisingly, the market has latched onto the worsening forecasts more than the expected 50bps hike and we have seen the pound fall more than 0.5% against the dollar and the euro immediately following the release. Longer dated gilt yields have also fallen following the release with the 2s10s curve inverting for the first time since 2019.
The dreary predictions from the MPC represent ongoing pain for the consumer and focus will quickly turn to politicians to act – with Liz Truss the heavy favourite to take the Tory leadership, she may find the position a poisoned chalice as she takes the wheel just as we enter the worst recession in over a decade.
This may not be enough to curb inflation
The independent Bank of England has never before put rates up by this much, but that doesn’t mean inflation will now come down. Currency traders reacted immediately, with GBP dropping fast against USD and EUR this afternoon. This breaks a trend for Sterling which has been in place since the first half of July.
“World events are still causing havoc and, with the US Fed raising rates at an even faster pace, the Bank must walk a tightrope between killing off demand and continuing to import too much inflation due to a weak Pound,” said Samuel Fuller, Director of Financial Markets Online. “The Bank is also soon to start selling off its mountain of gilts, which is already causing government borrowing costs to tick up. This could have unintended consequences too.”
Predictions of how bad it’s going to get seem to grow steadily worse, with credible forecasts that inflation will reach 15% early next year weighing heavily on sentiment. The UK might not have it as bad as places like Turkey, where inflation is pushing 80% a year, but that will come as cold comfort when the energy squeeze pushes the UK into dark and uncomfortable territory in the new year. Frankly, it’s an economic time bomb and rates are only going in one direction.
“The Bank of England is playing catch up after some bumper rate rises from the ECB and Federal Reserve in the last month,” said Nicholas Hyett, an investment analyst at the Wealth Club. “The resulting rate hike may be the largest in nearly 30 years, but it was also widely expected, and the market reaction has been modest. Instead, the real focus today is on how much further the bank is willing to go as it seeks to bring inflation back down to its 2% target.”
The current inflationary spike is being driven by global food and energy prices, and higher interest rates in the UK will do little to alleviate those pressures. Stronger sterling has the potential to provide some relief. However, rising rates in the US and Europe mean the BoEs actions haven’t helped the pound much, and sterling is currently trading near its weakest level against the dollar in over 40 years.
So what about consumers?gilt
The risk now is that higher interest rates start to squeeze consumer and commercial borrowers too much, strangling the life out of the economy without significantly easing the cost-of-living crisis.
Markets still think the Bank has a rate rise or two in the tank, but to some degree UK monetary policy is now caught in global forces over which the Bank has little control. Inflation will rise or fall according to what happens in Ukraine not Threadneedle Street, and rate decisions are dictated by moves at other central banks as much as by the MPC.