Bank of England Raise Interest Rates by 25 bps from 0.25% to 0.50% as Expected

The Bank of England MPC at its February meeting voted 5-4 (Ramsden, Saunders, Haskel, Mann wanted to hike by 50 bps to 0.75%) to raise the Bank Rate from 0.25% to 0.50%. The BoE voted unanimously to reduce the stock of UK government bond purchases

BankofEngland

Inflation is at the highest rate for a decade, the sharpest annual incline for 10 years and well above the Bank’s 2% target.  The BoE has warned there was unlikely to be any reprieve over the winter months from soaring energy costs driving up the rate to 6% next spring, this is three times the 2% official target.

The Bank of England was the first of its major global central bank peers to raise rates. The European Central Bank also said last month it would scale back its multi-trillion Euro quantitative easing pandemic support package. The US Federal Reserve last month said that it’s QE Taper would be doubled in pace of Treasuries $20B per month as expected, and MBS $10B per month as expected.

Despite the rate rise on Thursday, 0.50% is still a lower interest rate than before the pandemic, when borrowing costs were set at 0.75% before the first wave spread to Britain in early 2020.

Highlights 

Bank of England announced February 3, 2021, monetary policy decision

  • Rose from 0.25% to 0.50%
  • Official bank rate votes vote 5-4
  • Ramsden, Saunders, Haskel, Mann wanted to raise rates by 50 bps to 0.75%
  • Voted unanimously to reduce the stock of UK government bond purchases
  • Bank rate still preferred tool for adjusting monetary policy stance
  • Rate hike needed due to current tightness of labor market
  • There are also signs of greater persistence of domestic cost pressures
  • Minority camp think pay and other pressures could be more persistent than forecast
  • Minority camp believe that 50 bps rate hike would help check inflation expectations
United Kingdom Interest Rate
Bank of England Rates

Statement Breakdown

  • Inflation peak seen at around 7.25% in April (previously around 6.00%)
  • Inflation in two years’ time seen at 2.15% (previously 2.23%)
  • Inflation in one years’ time seen at 5.21% (previously 3.40%)
  • Inflation in three years’ time seen at 1.60% (previously 1.95%)

Market Reaction

Pound rose with the rise in rates

The pound immediately rose on the decision after The BOE matched market expectations again and rate watchers. GBPUSD up from 1.3550 to 1.3620. EUR/GBP fresh lows since February 2020 and is testing waters below key support at 0.8300.

Monetary Policy Summary, February 2021

The Bank of England’s Monetary Policy Committee (MPC) sets monetary policy to meet the 2% inflation target, and in a way that helps to sustain growth and employment. At its meeting ending on 2 February 2022, the MPC voted by a majority of 5-4 to increase Bank Rate by 0.25 percentage points, to 0.5%. Those members in the minority preferred to increase Bank Rate by 0.5 percentage points, to 0.75%. The Committee voted unanimously for the Bank of England to begin to reduce the stock of UK government bond purchases, financed by the issuance of central bank reserves, by ceasing to reinvest maturing assets. The Committee also voted unanimously for the Bank of England to begin to reduce the stock of sterling non-financial investment-grade corporate bond purchases, financed by the issuance of central bank reserves, by ceasing to reinvest maturing assets and by a programme of corporate bond sales to be completed no earlier than towards the end of 2023 that should unwind fully the stock of corporate bond purchases.

The Committee’s updated central projections for activity and inflation are set out in the accompanying February Monetary Policy Report. The projections are conditioned on a market-implied path for Bank Rate that rises to around 1½% by the middle of 2023. Wholesale energy prices are assumed to follow their respective futures curves for the first six months of the projections and remain constant beyond that, in contrast to futures curves, which are downward sloping over coming years. There are material risks around this assumption.

Global and UK activity returned to their pre-Covid-19 (Covid) levels towards the end of last year. The emergence of the Omicron variant is expected to have depressed activity somewhat in December and January. But its economic impact is likely to be limited and of short duration, and UK GDP is expected to recover in February and March such that output returns to its pre-pandemic level once again by the end of the first quarter. The Labour Force Survey unemployment rate fell to 4.1% in the three months to November, and is expected to fall further in the near term, to 3.8% in 2022 Q1.

Beyond the near term, UK GDP growth is expected to slow to subdued rates. The main reason for that is the adverse impact of higher global energy and tradable goods prices on UK real aggregate income and spending. As a result, the unemployment rate is expected to rise to 5% and excess supply builds to around 1% by the end of the forecast period.

Underlying earnings growth is estimated to have remained above pre-pandemic rates, and is expected to strengthen over the coming year, to around 4¾%. This is consistent with the results of the Bank’s Agents’ annual pay survey, with the tight labour market, and with some temporary upward pressure on wage settlements from higher price inflation.

Twelve-month CPI inflation rose from 5.1% in November to 5.4% in December, almost 1 percentage point higher than expected at the time of the November Report. Inflation is expected to increase further in coming months, to close to 6% in February and March, before peaking at around 7¼% in April. This projected peak is around 2 percentage points higher than expected in the November Report. The projected overshoot of inflation relative to the 2% target mainly reflects global energy and tradable goods prices. The further rise in energy futures prices meant that Ofgem’s utility price caps were expected to be substantially higher at the reset in April 2022. Core goods CPI inflation is also expected to rise further, due to the impact of global bottlenecks on tradable goods prices.

In the February Report central projection, upward pressures on CPI inflation are expected to dissipate over time, as global energy prices are assumed to remain constant after six months, and as global bottlenecks ease and tradable goods prices fall back a little. Underlying wage growth is also projected to ease from 2023, as the labour market loosens gradually and inflation declines. Conditioned on the rising market-implied path for Bank Rate and the MPC’s current forecasting convention for future energy prices, CPI inflation is projected to fall back to a little above the 2% target in two years’ time and to below the target by a greater margin in three years.

In an alternative scenario that is conditioned on energy prices following forward curves throughout the forecast period and as set out in the February Report, excess supply is around ½ percentage point lower in the medium term than in the MPC’s central projection, and CPI inflation is around ¾ percentage point below the 2% target in two and three years’ time.

The MPC’s remit is clear that the inflation target applies at all times, reflecting the primacy of price stability in the UK monetary policy framework. The framework also recognises that there will be occasions when inflation will depart from the target as a result of shocks and disturbances. In the recent unprecedented circumstances, the economy has been subject to very large and repeated shocks. In particular, should recent movements prove persistent, the sharp rises in prices of global energy and tradable goods of which the United Kingdom is a net importer will necessarily weigh on UK real aggregate income and spending. This is something monetary policy is unable to prevent. The role of monetary policy is to ensure that, as such a real economic adjustment occurs, it does so consistent with achieving the 2% inflation target sustainably in the medium term, while minimising undesirable volatility in output.

Given the current tightness of the labour market and continuing signs of greater persistence in domestic cost and price pressures, the Committee judges that an increase in Bank Rate of 0.25 percentage points is warranted at this meeting.

Consistent with the MPC’s guidance set out in the August 2021 Report, the Committee agrees at this meeting that the Bank of England should cease to reinvest any future maturities falling due from its stock of UK government bond purchases. This reflects the MPC’s intention to reduce its holdings of government bonds in a gradual and predictable manner.

In addition, the Committee agrees that the Bank of England should cease to reinvest any maturities falling due from its stock of sterling non-financial investment-grade corporate bond purchases, and that it should initiate a programme of corporate bond sales to be completed no earlier than towards the end of 2023 that should unwind fully the stock of corporate bond purchases.

The decision to initiate the programme of corporate bond sales reflects the specific characteristics of the corporate bond market and the MPC’s involvement in it, and should not be taken as a signal regarding the commencement, scale or duration of any potential future UK government bond sales programme.

The Committee reaffirms that it will consider beginning the process of actively selling UK government bonds only once Bank Rate has risen to at least 1%, and depending on economic circumstances at the time. The Committee also reaffirms its preference in most circumstances to use Bank Rate as its active policy tool when adjusting the stance of monetary policy.

The extent of any further tightening in monetary policy will depend on the medium-term prospects for inflation. The MPC judges that, if the economy develops broadly in line with the February Report central projections, some further modest tightening in monetary policy is likely to be appropriate in the coming months. The Committee continues to judge that there are two-sided risks around the medium-term inflation outlook, primarily from wage developments on the upside and from energy and global tradable goods prices on the downside. The Committee will update its assessment on the balance of the risks to medium-term inflation in light of the relevant data as they emerge.

Source: Bank of England

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