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Is the Bank of England losing the plot?

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The Bank of England (BoE) yesterday raised UK base rates by another 25bps, but the move has now split opinion in the market and among forex analysts. One of the few bright spots from commentators was the fact that the GBP was rallying and that this would make for cheaper holidays abroad this summer.

David Morrison, Senior Market Analyst at Trade Nation, explained that the hike isn’t a surprise given the current rate of inflation. The rate rise will strengthen the pound, but only if additional hikes are expected.

“Rates will likely continue to rise”

“This doesn’t come as a surprise, particularly since inflation has exceeded 10% for the last seven months, five times the BoE’s 2% target,” he said. “Now, analysts are questioning how many more increases will occur this year. At Trade Nation, we believe that rates will likely continue to rise in the coming months with a possibility that we reach 5% by year-end. However, there’s also an expectation that we’ll soon see a large drop in the headline CPI as the base effects of last year’s energy rises flatter the comparison with this year’s numbers.”

Morrison said that sterling should continue its rally against the US dollar for as long as the consensus holds for higher UK rates, along with the prediction that US Federal Reserve will pause their programme of rate hikes. Last week, sterling hit a one-year high against the dollar, a trend that Trade Nation expects to continue as the UK economy exceeds expectations.

That said, sterling dropped off against the USD on Thursday and was down substantially, at 1.253, well off its levels going into the week. Sterling also fell against the EUR but traders were buying the pound again Friday as some anaemic UK economic data filtered out, showing some levels of growth continuing.


But others are less sanguine about the Bank’s performance. Trevor Williams, Chair of the Institute of Economic Affairs’ Shadow Monetary Policy Committee and former chief economist at Lloyds Bank, is critical of the way the Bank of England is handling things.

“The Bank of England helped create the inflation problem, then said there wasn’t a problem, then called it ‘temporary’, and now runs a significant risk of overcorrecting,” Williams said. “Just as the Bank of England failed to identify inflationary pressures at the tail end of the COVID-19 pandemic, they may be once again focusing too much on present inflation rather than long run trends. The sharp reduction in the money supply points towards inflation coming down quickly over the coming two years. The UK’s sluggish economic growth, easing supply chain pressures and a series of recent bank failures also point against the need for further rate rises.”

Williams said that inflation could still dip to around 1 per cent over the next two to three years and even after adjusting for the Bank’s revised forecast suggesting stronger growth, it is expected to undershoot the 2 per cent target. This trajectory indicates interest rates need not go up any further.

UK inflation still running hot

The UK inflation picture is still running hot and does not compare well when stacked up against the other G20 countries. Nor does the economic forecast picture make pleasant reading, with the UK still regarded as one of the developed countries most likely to hit recession in 2023. The Bank – and the UK government – seem extremely keen to avoid a recession which would be politically harmful with an election year in the offing.

Mike Owens, Senior Sales Trader at Saxo said: “With UK inflation still in double digits it certainly seems unlikely the Bank will be able to stop here and the market is now pricing for interest rates peaking at near 5% in September 2023, which is higher than the Bank’s own assumption of 4.75%.”

The Bank revised up its forecast for UK GDP which is a huge reversal since it’s recession prediction from November but with that stronger assessment for the economy comes the need to do more to tame inflationary pressure which is why the briefing is being seen as hawkish.

From this point much will depend of the strength of the inflation and wage data with the Bank also mindful of the pain being felt by mortgage holders after 12 consecutive rate increases.

“Yesterday’s quarter point rise has taken interest rates to the highest level since 2008,” observed Jatin Ondhia, CEO of Shojin. “With inflation still running hot, it remains to be seen how much further monetary policy intervention will be required to restore price stability in what has been a historic series of hikes. Undoubtedly, investors will be hoping that the summit may be drawing near, but for now, the Bank of England’s tricky juggling act looks set to continue. Going into the second half of the year, agility and diversification will be key in navigating the shifting macroeconomic landscape as the tightening of financial conditions continue to feed through into the economy.”

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This article does not constitute investment advice. Do your own research or consult a professional advisor.

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