The Bank of England on Thursday is broadly expected to hike interest rates by 50 basis points, its largest single increase since 1995.
Such a move would take borrowing costs to 1.75% as the central bank battles soaring inflation and would be the first half-point hike since it was made independent from the British government in 1997.
U.K. inflation hit a new 40-year high of 9.4% in June as food and energy prices continued to surge, deepening the country’s historic cost-of-living crisis.
Bank of England Governor Andrew Bailey suggested in a hawkish speech on July 19 that the Monetary Policy Committee could consider a 50-basis point hike, vowing that there would be “no ifs or buts” in the Bank’s commitment to returning inflation to its 2% target.
A poll taken over the past week indicated that over 70% of market participants now anticipate a half-point rise.
James Smith, developed markets economist at ING, said that although the economic data since June’s 25 basis point hike had not moved the needle significantly, the MPC’s prior commitment to act “forcefully” to bring inflation down, and the market more-or-less pricing in 50 basis points at this stage, means policymakers are likely to err on the aggressive side.
“Even so, the window for further rate hikes feels like it’s closing. Markets have already pared back expectations for ‘peak’ Bank Rate from 3.5% to 2.9%, though that still implies two further 50bp rate hikes by December, plus a little more thereafter,” Smith said.
“That still feels like a stretch. We’ve been penciling in a peak for Bank Rate at 2% (1.25% currently), which would mean just one more 25bp rate hike in September before policymakers stop tightening.”
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He acknowledged that, in practice, this might be an underestimate and depending on the signal the Bank sends on Thursday, ING would not rule out an additional 25bps or at most 50ps worth of hikes beyond that.
Smith said the key points to watch out for in Thursday’s report would be whether the Bank continues to use the word “forcefully,” and its forecasts, which plug market expectations into the Bank’s models and expected policy trajectory.
Should the forecasts indicate, as in previous iterations, an acceleration of unemployment and inflation well below target in two to three years’ time, markets could deduce a more dovish message.
“Everybody takes that as a sign of them saying ‘okay, well if we were to follow through with what markets are expecting, then inflation is going to be below target,’ which is their very indirect way of saying ‘we don’t need to hike as aggressively as markets expect,’” Smith said on Tuesday.
“I think that will be repeated, I would expect, and that should be taken as a bit of a sign maybe that we’re nearing the end of the tightening cycle.”
Growth Worries
A more aggressive approach at Thursday’s meeting would bring the Bank’s monetary tightening trajectory closer to the trend set by the U.S. Federal Reserve and the European Central Bank, which implemented 75 and 50 basis point hikes last month, respectively.
But while it may fortify the Bank’s inflation-fighting credibility, the faster pace of tightening will exacerbate downside risks to the already-slowing economy.
Berenberg Senior Economist Kallum Pickering said in a note Monday that Governor Bailey will likely carry a majority of the nine-member MPC if he backs a 50-basis point hike on Thursday and projected that with inflation likely still rising¸ the Bank will hike by another 50bp in September.
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“Thereafter, the outlook is uncertain. Inflation will likely peak in October when the household energy price cap increases again. Amid growing evidence that tighter monetary conditions are weighing on demand and underlying inflation, we expect the BoE to hike by a further 25bp in November but pause in December,” Pickering said.
Berenberg expects the bank rate to reach 2.5% in November, up from 1.25% at present, though Pickering said the risks to this call are tilted to the upside. He suggested the BOE should be able to reverse some of the tightening during 2023 as inflation begins to roll over and will likely cut the bank rate by 50 basis points next year with a further 50bp reduction in 2024.
Energy Price Cap Rise
Britain’s energy regulator Ofgem increased the energy price cap by 54% from April to accommodate soaring global costs but is expected to rise by a greater degree in October, with annual household energy bills predicted to surpass £3,600 ($4,396).
Barclays has historically been cautious on bank rates, placing a lot of faith in the MPC’s “early and gradual” strategy. However, Chief U.K. Economist Fabrice Montagne told CNBC in an email last week that there is now a case for policymakers to act “forcefully” as energy prices continue to spiral.
“In particular, surging energy prices are feeding into our forecast of the Ofgem price cap and will force the BoE to revise up its inflation forecast yet again. Higher inflation for even longer is the kind of scenario that spooks central banks because of higher risks of persistence and spillovers,” he said.
The British banking giant now expects a 50-basis point hike on Tuesday followed by 25 basis points in September and then “status quo” at 2%.
From CNBC
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