Bank of England Raises Interest Rates 50bps to 4.0%, Projects Inflation Likely Peaked

The Bank of England MPC at its December meeting Thursday raised the key bank rate by 50 bps from 3.50% to 4.00% as expected. It was the 10th consecutive rate hike and BoE’s benchmark rate puts the cost of borrowing at the highest level since late-2008. The vote was 7-2 (Tenreyro and Dhingra voted to keep rates unchanged, similar to the December meeting). The BoE’s projections again suggested CPI inflation has reached its peak, with the central bank dropping its pledge to keep increasing rates “forcefully” if needed, suggesting it might start reducing the pace of rate increases soon.

Looking ahead, Bank Rate is seen rising to around 4.50 percent in mid-2023 and falls back to just over 3.25 percent in three years’ time.

BankofEngland

The BOE changed to “if there were to be evidence of more persistent pressures, then further tightening in monetary policy would be required” instead of having previous “respond forcefully, as necessary”. Suggests the Bank is reaching a point where a slower pace of rate hikes will be needed, and a peak is coming in soon.

It had been the first time since January 2009 that the rate has been higher than 1%. At its May meeting, the BoE increased the base rate to 1%. From there we have seen another eight raises.

Highlights 

Bank of England announced February 2, 2023, monetary policy decision

  • BOE raises bank rate 50 bps to 4.00%, as expected
  • Bank rate vote 7-2 vs 7-2 expected (Tenreyro and Dhingra voted to keep rates unchanged, similar to the December meeting)
  • Further increases in bank rate may be required
  • If there were to be evidence of more persistent pressures, then further tightening of monetary policy would be required.
  • CPI likely to have peaked
  • Inflation to fall to 3.92% by Q4 2023 (previous forecast 5.2%)
  • Inflation risks still skewed significantly to the upside

The Bank of England was the first of its major global central bank peers to raise rates in this cycle. The Federal Reserve raised rates by a quarter of a percent at their March meeting. The interest rate before the pandemic were set at 0.75% before the first wave spread to Britain in early 2020.

The rise in borrowing costs will add further pressure on household budgets already burdened by a sharp rise in energy and food prices next month, and the prospect of higher taxes.

United Kingdom Interest Rate
Bank of England Rates

Inflation Crushing Economic Growth

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 annual inflation rate in the UK fell to 10.5% in December of 2022 from 10.7% in November, matching market forecasts. It marked a second consecutive month of slowing inflation and the lowest rate in three months, after a peak of 11.1% in October.

The largest downward contribution came from transport prices (6.5% vs 7.2%), namely motor fuels. Average petrol prices fell by 8.3 pence per litre between November and December. Prices also eased for clothing and footwear (6.5% vs 7.5%) and recreation and culture (4.9% vs 5.3%), mainly games, toys and hobbies. On the other hand, prices rose faster for restaurants and hotels (11.3%, the largest since 1991 vs 10.2%), particularly accommodation, and food and non-alcoholic beverages (16.8%, which is the highest since 1977 according to modelled estimates vs 16.4%).

Compared to the previous month, the CPI increased 0.4%, the same as in November and also in line with forecasts. 

Market Reaction

The split in votes hurt the pound. The pound is struggling with GBPUSD to just below 1.2300 and threatening a break of its recent consolidation. EUR/GBP at .8929 pushing towards 0.9000.

Monetary Policy Summary, February 2023

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 1 February 2023, the MPC voted by a majority of 7–2 to increase Bank Rate by 0.5 percentage points, to 4%. Two members preferred to maintain Bank Rate at 3.5%.

Global consumer price inflation remains high, although it is likely to have peaked across many advanced economies, including in the United Kingdom. Wholesale gas prices have fallen recently and global supply chain disruption appears to have eased amid a slowing in global demand. Many central banks have continued to tighten monetary policy, although market pricing indicates reductions in policy rates further ahead.

UK domestic inflationary pressures have been firmer than expected. Both private sector regular pay growth and services CPI inflation have been notably higher than forecast in the November Monetary Policy Report. The labour market remains tight by historical standards, although it has started to loosen and some survey indicators of wage growth have eased, alongside a gradual decline in underlying output. Given the lags in monetary policy transmission, the increases in Bank Rate since December 2021 are expected to have an increasing impact on the economy in the coming quarters.

Near-term data developments will be crucial in assessing how quickly and to what extent external and domestic inflationary pressures will abate. As set out in the accompanying February Monetary Policy Report, the MPC’s updated projections show CPI inflation falling back sharply from its current very elevated level, of 10.5% in December, in large part owing to past increases in energy and other goods prices falling out of the calculation of the annual rate. Annual CPI inflation is expected to fall to around 4% towards the end of this year, alongside a much shallower projected decline in output than in the November Report forecast.

In the latest modal forecast, conditioned on a market-implied path for Bank Rate that rises to around 4½% in mid-2023 and falls back to just over 3¼% in three years’ time, an increasing degree of economic slack, alongside falling external pressures, leads CPI inflation to decline to below the 2% target in the medium term. There are considerable uncertainties around this medium-term outlook, and the Committee continues to judge that the risks to inflation are skewed significantly to the upside.

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 recognises that there will be occasions when inflation will depart from the target as a result of shocks and disturbances. The economy has been subject to a sequence of very large and overlapping shocks. Monetary policy will ensure that, as the adjustment to these shocks continues, CPI inflation will return to the 2% target sustainably in the medium term. Monetary policy is also acting to ensure that longer-term inflation expectations are anchored at the 2% target.

The Committee has voted to increase Bank Rate by 0.5 percentage points, to 4%, at this meeting. Headline CPI inflation has begun to edge back and is likely to fall sharply over the rest of the year as a result of past movements in energy and other goods prices. However, the labour market remains tight and domestic price and wage pressures have been stronger than expected, suggesting risks of greater persistence in underlying inflation.

The extent to which domestic inflationary pressures ease will depend on the evolution of the economy, including the impact of the significant increases in Bank Rate so far. There are considerable uncertainties around the outlook. The MPC will continue to monitor closely indications of persistent inflationary pressures, including the tightness of labour market conditions and the behaviour of wage growth and services inflation. If there were to be evidence of more persistent pressures, then further tightening in monetary policy would be required.

Looking further ahead, the MPC will adjust Bank Rate as necessary to return inflation to the 2% target sustainably in the medium term, in line with its remit.

Source: Bank of England

From The TradersCommunity News Desk