Bank of England continues largest rate hike in 27 years as inflation rises

LONDON, February 3: Bank of England Governor Andrew Bailey departs after a press conference at the Bank of England on February 3, 2022 in London, England. The Bank is expected to raise interest rates for its fifth consecutive meeting on Thursday, but faces a difficult balancing act between supporting growth and curbing inflation.

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LONDON – The Bank of England is expected to raise interest rates by 50 basis points on Thursday, the largest increase since 1995.

Such a move would bring borrowing costs to 1.75% as the central bank struggles with rising inflation, and would be the first half-point increase since the central bank gained independence from the UK government in 1997.

Inflation in the UK hit a new 40-year high of 9.4% in June, as food and energy prices continued to rise, exacerbating the country’s historic cost of living crisis.

Bank of England Governor Andrew Bailey, in an aggressive speech on July 19, suggested that the Monetary Policy Committee might consider a 50 basis point increase, vowing there would be “no ifs or buts” in the commitment from the Bank of England. Bank to bring inflation back to its target of 2% .

A Reuters poll last week found that more than 70% of market participants now expect a half-point rise.

James Smith, developed markets economist at ING, said that while economic data hadn’t moved the needle significantly since the 25 basis point gain in June, the MPC’s earlier commitment to take “vigorous” action to lower inflation, and the market more or less pricing in 50 basis points at this stage means that policymakers are likely to err on the aggressive side.

Nevertheless, the window for further rate hikes feels like it is closing. Markets have already scaled back expectations for ‘peak’ bank rates from 3.5% to 2.9%, although that still means two further 50bp rate hikes in December means, plus a little more after that,” says Smit.

“That still feels like a task. We predict a peak for the bank interest rate of 2% (1.25%).

He acknowledged that in practice this could be an underestimate, and depending on the signal the bank sends on Thursday, ING is not ruling out a further 25bps or 50ps at most.

Smith said the key points to look for in Thursday’s report are whether the Bank will continue to use the word “vigorous” and its forecasts, which align market expectations with the Bank’s models and projected policy trajectory.

Should the forecasts, as in previous iterations, point to an acceleration in unemployment and inflation well below target in two to three years, markets could be sending a more subdued message.

“Everyone takes that as a sign that they’re saying, ‘Okay, if we continued with what the markets expect, inflation will be below target’, which is their very indirect way of saying, ‘We don’t have need to walk as aggressively as the markets expect,” Smith told CNBC on Tuesday.

“I think that will be repeated, I would expect, and that should be taken as a sign that we may be approaching the end of the tightening cycle.”

Growth concerns

A more aggressive approach at Thursday’s meeting would bring the Bank’s monetary tightening trajectory closer to the trend of the US Federal Reserve and European Central Bank, which increased 75 and 50 basis points respectively last month.

But while it could bolster the Bank’s inflation-fighting credibility, the faster pace of tightening will increase downside risks to the already slowing economy.

Berenberg Senior Economist Kallum Pickering said in a note Monday that Governor Bailey is likely to carry a majority of the nine-member MPC if he backs a 50 basis point hike on Thursday, and forecast that as inflation is likely to continue to climb, the Bank will continue to increase by more will increase once. 50bp in Sept.

“After that, the outlook is uncertain. Inflation is likely to peak in October, when the energy ceiling for households rises again. Amid mounting evidence that tighter monetary conditions are weighing on demand and underlying inflation, we expect the BoE to rise even further in November. will rise once 25bp but pause in December,” Pickering said.

Berenberg expects bank rates to reach 2.5% in November, up from 1.25% now, although Pickering said the risks of this call are on the upside. He suggested that the BOE should be able to reverse some of the tightening in 2023 when inflation starts to roll, and is likely to cut bank rates by 50 basis points next year, with a further 50 basis point cut in 2024.

Increase in energy price ceiling

UK energy regulator Ofgem raised the energy price cap by 54% from April to cushion rising global costs, but is expected to rise at a higher rate in October, with annual household energy bills expected to exceed £3,600 ($4,396).

Barclays has been cautious on bank rates in the past and is very confident in the MPC’s “early and gradual” strategy. However, Chief UK Economist Fabrice Montagne told CNBC in an email last week that there is now a reason for policymakers to act “forcefully” as energy prices continue to rise.

Rising energy prices, in particular, add to our forecast of the Ofgem price cap and will force the BoE to reconsider its inflation forecast. Higher inflation for even longer is the kind of scenario that deters central banks due to the greater risks of persistence and spillovers.” he said.

The British banking giant now expects an increase of 50 basis points on Tuesday, followed by 25 basis points in September and then “status quo” at 2%.

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