The Bank of England MPC at its November meeting Thursday raised the key bank rate by 75 bps from 2.25% to 3.00% as expected. BoE’s benchmark rate has not gone up this quickly since November 1989 when it rose from 13.75% to 14.875%. An even bigger hike was briefly imposed on Black Wednesday in Sep1992 but was revoked by then Chancellor Lamont. The vote was 9-0 (However Tenreyro voted for 25 bps, Dhingra voted for 50 bps). The UK has been in political turmoil with three prime ministers in seven weeks leading to turmoil in the gilt and sterling markets.
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 had already warned there was unlikely to be any reprieve over the winter months from soaring energy costs. Uncertainty around the outlook for UK retail energy prices has fallen after government’s energy support plan.
“The pandemic was a common shock to all of us, the war is not,” said Deputy Gov. Ben Broadbent, referring to the conflict in Ukraine. “We have a really big difference in the path of growth and that explains quite a lot of what divergence there is in policy.”.
It is 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 seven raises.
Highlights
Bank of England announced November 3, 2022, monetary policy decision
- BOE raises bank rate 75 bps to 3.00%, as expected
- Bank rate vote 9-0* vs 9-0 expected (*Tenreyro voted for 25 bps, Dhingra voted for 50 bps)
- Majority of policymakers judge further increases in bank rate may be required but to a lower peak than 5.20% priced into markets
- Outlook for UK economy is “very challenging”
- Financial conditions have tightened materially since August
- Majority of policymakers believe 75 bps rate hike would reduce risk of extended, costly tightening later
- CPI inflation projected to pick up to around 11% in 2022 Q4, lower than was expected in August
- GDP is still expected to be falling at the end of 2023
- There are considerable uncertainties around the outlook
- If the outlook suggests more persistent inflationary pressures, BOE will respond forcefully, as necessary
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.
Inflation Crushing Economic Growth
The central bank also notes a lower inflation projection, but they are viewing a stagflation outlook.
“It is a tough road ahead,” Bank of England Gov. Andrew Bailey said at a news conference. “The sharp rise in energy prices has made us poorer as a nation.” “Further increases in Bank Rate may be required for a sustainable return of inflation to target, albeit to a peak lower than priced into financial markets”.
The U.K.’s rate of inflation hit a 40-year high of 9% in April and hasn’t looked back, the fastest rise in prices recorded by one of the G7 economies since the current surge began at the start of last year. The rise in rates and gloom of the economy is hitting economic growth. Real wages are also falling behind.
The central bank’s decision to raise borrowing costs will add to the difficulties facing households and businesses as they prepare to navigate a winter of recession and rising prices, a combination that will squeeze incomes.
On Monday data showed households cut their credit-card borrowing to £100 million pounds in September from £700 million in August, while new loans for house purchases fell to 66,800 from 74,400. A survey of manufacturers PMI released Tuesday showed factory output fell in October, while a sharp decline in new orders prompted the first reduction in employment in almost two years. U.K.’s October Services PMI 48.8 (expected 47.5; last 50.0) recorded the largest decline in activity since January 2021, when the economy was in lockdown to contain the Covid-19 pandemic.
The U.K. faces the weakest outlook for growth among the Group of 20 large economies, with the exception of Russia. In a report released last week, the Organization for Economic Cooperation and Development (OECD) said it expected the U.K.’s economy to stagnate in 2023, with the U.S. forecast to grow 1.2% and the eurozone by 1.6%.
Market Reaction
After the BOE’s announcement, the pound weakened against the dollar to trade 1.9% lower. Cable was down 211 pips to 1.1179. The pound was already the weakest currency of the majors following yesterday’s Federal Reserve rate hike and Chairman Powells’s hawkish statement.
U.K. government bonds sold off. The yield on the 10-year bond rose to 3.504%, from 3.421% the previous day. Shorter-dated bonds initially rallied but reversed to sell off as well.
Monetary Policy Summary, November 2022
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 November 2022, the MPC voted by a majority of 7-2 to increase Bank Rate by 0.75 percentage points, to 3%. One member preferred to increase Bank Rate by 0.5 percentage points, to 2.75%, and one member preferred to increase Bank Rate by 0.25 percentage points, to 2.5%.
As set out in the accompanying November Monetary Policy Report, the MPC’s updated projections for activity and inflation describe a very challenging outlook for the UK economy.
Since the MPC’s previous forecast, there have been significant developments in fiscal policy. Uncertainty around the outlook for UK retail energy prices has fallen to some extent following further government interventions. For the current November forecast, and consistent with the Government’s announcements on 17 October, the MPC’s working assumption is that some fiscal support continues beyond the current six-month period of the Energy Price Guarantee (EPG), generating a stylised path for household energy prices over the next two years. Such support would mechanically limit further increases in the energy component of CPI inflation significantly, and reduce its volatility. However, in boosting aggregate private demand relative to the August projections, the support could augment inflationary pressures in non-energy goods and services.
Other fiscal measures announced up to and including 17 October also support demand relative to the August projection. The MPC’s forecast does not incorporate any further measures that may be announced in the Autumn Statement scheduled for 17 November.
There have been large moves in UK asset prices since the August Report. These partly reflect global developments, although UK-specific factors have played a very significant role during this period. The MPC’s projections are conditioned on the path of Bank Rate implied by financial markets in the seven working days leading up to 25 October. That path rose to a peak of around 5¼% in 2023 Q3, before falling back. Overall, the path is around 2¼ percentage points higher over the next three years than in the August projection. The higher market yield curve has pushed new mortgage rates up sharply. Financial conditions have tightened materially, pushing down on activity over the forecast period.
GDP is expected to decline by around ¾% during 2022 H2, in part reflecting the squeeze on real incomes from higher global energy and tradable goods prices. The fall in activity around the end of this year is expected to be less marked than in August, however, reflecting support from the EPG. The labour market remains tight, although there are signs that labour demand has begun to ease.
CPI inflation was 10.1% in September and is projected to pick up to around 11% in 2022 Q4, lower than was expected in August, reflecting the impact of the EPG. Services CPI inflation has risen. Nominal annual private sector regular pay growth rose to 6.2% in the three months to August, 0.6 percentage points higher than expected in the August Report.
In the MPC’s November central projection that is conditioned on the elevated path of market interest rates, GDP is projected to continue to fall throughout 2023 and 2024 H1, as high energy prices and materially tighter financial conditions weigh on spending. Four-quarter GDP growth picks up to around ¾% by the end of the projection. Although there is judged to be a significant margin of excess demand currently, continued weakness in spending is likely to lead to an increasing amount of economic slack emerging from the first half of next year, including a rising jobless rate. The LFS unemployment rate is expected to rise to just under 6½% by the end of the forecast period and aggregate slack increases to 3% of potential GDP.
In the MPC’s central projection, CPI inflation starts to fall back from early next year as previous increases in energy prices drop out of the annual comparison. Domestic inflationary pressures remain strong in coming quarters and then subside. CPI inflation is projected to fall sharply to some way below the 2% target in two years’ time, and further below the target in three years’ time.
In projections conditioned on the alternative assumption of constant interest rates at 3%, activity is stronger than in the MPC’s forecast conditioned on market rates, although GDP is still expected to be falling at the end of 2023. CPI inflation is projected to be a little above the target at the end of the second year. However, it falls more than a percentage point below the target at the end of the third year.
The risks around both sets of inflation projections are judged to be skewed to the upside in the medium term, however, in part reflecting the possibility of more persistence in wage and price setting.
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 succession of very large 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 labour market remains tight and there have been continuing signs of firmer inflation in domestic prices and wages that could indicate greater persistence. Currently announced fiscal policy, including the MPC’s working assumption about continued fiscal support for household energy prices, will also support demand, relative to the Committee’s projections in August. The Committee will take account of any additional information in the Government’s Autumn Statement at its December meeting and in its next forecast in February.
In view of these considerations, the Committee has voted to increase Bank Rate by 0.75 percentage points, to 3%, at this meeting.
The majority of the Committee judges that, should the economy evolve broadly in line with the latest Monetary Policy Report projections, further increases in Bank Rate may be required for a sustainable return of inflation to target, albeit to a peak lower than priced into financial markets.
There are, however, considerable uncertainties around the outlook. The Committee continues to judge that, if the outlook suggests more persistent inflationary pressures, it will respond forcefully, as necessary.
The MPC will take the actions necessary to return inflation to the 2% target sustainably in the medium term, in line with its remit. The Committee will, as always, consider and decide the appropriate level of Bank Rate at each meeting.
Source: Bank of England
From The TradersCommunity News Desk