Bank of England Raises Interest Rates to 15-year High 5.00%, Risk of British Recession Increases

The Bank of England MPC at its May meeting Thursday raised the key bank rate by raised by 50 bps to 5.00% as expected by many after the previous days hot inflation numbers. It was the 13th 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 last meeting). The bank risks pushing the UK into a brutal recession in its attack on Britain’s chronic inflation rate stuck at 8.7 per cent, and core inflation still accelerating. The BOE flagged that more action may be needed, as it monitors faster than expected wages growth, relatively buoyant consumer spending, and sticky services inflation.

BankofEngland

The situation seems to be out of control and the Central Bank prepared to damage Britain’s economy in the name of inflation. The moves have been devastating for the UK. s mortgage holders. Retail sales recently registered their first positive quarter in 18 months, and consumer confidence had picked up. Right now, the jobs market remains at its tightest in decades, with unemployment of 3.8 per cent. The bank said businesses were still finding it hard to recruit staff, but not as difficult as before.

“There has been significant upside news in recent data that indicates more persistence in the inflation process, against the background of a tight labour market and continued resilience in demand,” the MPC said in a statement after the meeting.

United Kingdom Interest Rate
Bank of England Rates

Highlights 

Bank of England announced June 2023, monetary policy decision.

  • BOE raises bank rate 50 bps to 5.00%, as expected by many after the previous days hot inflation numbers
  • Bank rate vote 7-2 vs 7-2 expected (Tenreyro and Dhingra voted to keep rates unchanged, similar to the last meetings)
  • Further increases in bank rate may be required
  • if there were to be evidence of more persistent pressures, then further tightening in monetary policy would be required
  • Continuing to monitor closely the impact of the significant rate hikes so far
  • Core goods price inflation has also been much stronger than projected
  • But CPI inflation is expected to fall significantly further during the course of the year
  • Food price inflation is projected to fall further in coming months
  • If there were to be evidence of more persistent pressures, then further tightening in monetary policy would be required
  • The bank did not issue a forecast, but said its business surveys suggested economic growth of about 0.25 per cent through the middle of the year, as the strong labor market props up household spending. This compares to estimates “flat” GDP for Q1 and Q2 last meeting (March forecast was -0.1% q/q for Q1)

When BoE started this rate cycle it had been the first time since January 2009 that the rate has been higher than 1%. At its May 2022 meeting, the BoE increased the base rate to 1%. Today was its 13th consecutive increase in borrowing costs which began in December 2021.

BOE Statement Changes:

Unlike FOMC, BoE knows how to change a statement – here June vs. May via John J. Hardy @johnjhardy

The Bank of England was the first of its major global central bank peers to raise rates in this cycle. 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 Too High

Inflation is in the sharpest annual incline for 10 years and well above the Bank’s 2% target.  Britain’s headline inflation was 8.7 per cent in May, unchanged from April. But the real concern was core inflation, which excludes energy, food, alcohol and tobacco, which ticked up from 6.8 per cent in April to 7.1 per cent in May, driven by services.

Note that the BoE has readjusted part of its focus from inflation forecasts to actual inflation figures as a determinant of policy decisions.

BOE’s Comments:

  • “The second-round effects in domestic price and wage developments generated by external cost shocks are likely to take longer to unwind than they did to emerge.”
  • The MPC said it would watch the labor market, wages and services prices for “indications of persistent inflationary pressures”.
  • “If there were to be evidence of more persistent pressures, then further tightening in monetary policy would be required.”

The bank said core goods inflation was driven up by a shortage of second-hand cars, after a slump in production two or three years ago because of the semiconductor shortage. The biggest component of services inflation was airfares and package holidays.

The BoE said falling household energy prices would help bring prices down, and would help temper inflation expectations, which were easing but still above average.

Monetary Policy Summary, June 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 21 June 2023, the MPC voted by a majority of 7–2 to increase Bank Rate by 0.5 percentage points, to 5%. Two members preferred to maintain Bank Rate at 4.5%.

At the time of the previous MPC meeting and May Monetary Policy Report, the market-implied path for Bank Rate averaged just over 4% over the next three years. Since then, gilt yields have risen materially, particularly at shorter maturities, now suggesting a path for Bank Rate that averages around 5½%. Mortgage rates have also risen notably. The sterling effective exchange rate has appreciated further.

The Committee is continuing to monitor closely the impact of the significant increases in Bank Rate so far. As set out in the May Report, the greater share of fixed-rate mortgages means that the full impact of the increase in Bank Rate to date will not be felt for some time.

Business surveys continue to suggest underlying quarterly GDP growth of around ¼% during the middle of this year. Indicators of household spending have tended to strengthen a little. LFS employment increased by 0.8% in the three months to April, higher than expected at the time of the May Report. The counterpart to this strong employment growth has been a further fall in the inactivity rate. The unemployment rate has been flat at 3.8%, in line with the May Report. The vacancies-to-unemployment ratio has fallen further but remains significantly elevated.

Annual growth in private sector regular Average Weekly Earnings (AWE) increased to 7.6% in the three months to April, 0.5 percentage points above the expectation at the time of the May Report. Three-month on three-month growth in this measure of pay has also picked up. Indications of future pay growth from the KPMG/REC survey and the Bank’s Agents suggest that AWE growth will ease over the rest of this year, however.

Twelve-month CPI inflation fell from 10.1% in March to 8.7% in April and remained at that rate in May. This is 0.3 percentage points higher than expected in the May Report. Services CPI inflation rose to 7.4% in May, 0.5 percentage points stronger than expected at the time of the May Report, while core goods price inflation has also been much stronger than projected. In general, news in the latter component is less likely to imply persistent inflationary pressures.

CPI inflation is expected to fall significantly further during the course of the year, in the main reflecting developments in energy prices. Services CPI inflation is projected to remain broadly unchanged in the near term. Core goods CPI inflation is expected to decline later this year, supported by developments in cost and price indicators earlier in the supply chain. In particular, annual producer output price inflation has fallen very sharply in recent months. Food price inflation is projected to fall further in coming months.

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. Monetary policy will ensure that CPI inflation returns to the 2% target sustainably in the medium term.

The MPC recognises that the second-round effects in domestic price and wage developments generated by external cost shocks are likely to take longer to unwind than they did to emerge. There has been significant upside news in recent data that indicates more persistence in the inflation process, against the background of a tight labour market and continued resilience in demand. At this meeting, the Committee voted to increase Bank Rate by 0.5 percentage points, to 5%.

The MPC will continue to monitor closely indications of persistent inflationary pressures in the economy as a whole, including the tightness of labour market conditions and the behaviour of wage growth and services price inflation. If there were to be evidence of more persistent pressures, then further tightening in monetary policy would be required.

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.

Fixed rate timebomb looms

The rise in rates has a potential impact of the monetary squeeze on the large number of households who will come off fixed-rate mortgages in the coming year. The so-called “mortgage timebomb” arises from previous government policies to help first-home buyers, such as stamp duty holidays. This prompted a bunching several years ago of only scarcely affordable house purchases on fixed rates. These rates that will expire this year. Commercial mortgage rates have jumped abruptly in recent weeks on inflation concerns, liquidity issues and BOE policy.

According to UK Finance, just over 80% of outstanding UK mortgages are fixed rate and in late-2021just as the BoE embarked on its hiking cycle 96% of new mortgages were taken out on fixed rates.

In the UK, those who took out 2-yr fixed mortgages at the time may be in for, or are already seeing, a significant increase in mortgage payments. Across all homeowners, UK Finance claims that around 800k fixed mortgage agreements end in H2-23 from a pool of 8.5mn; over the totality of 2024, they estimate that about 1.6mn deals expire. From 2.5% in late-2021, the average two-year fixed rate has climbed to just above 6% as of earlier this week, according to Moneyfacts.

“The greater share of fixed-rate mortgages means that the full impact of the increase in Bank rate to date will not be felt for some time,” the Bank admitted.

UK Chancellor Jeremy Hunt mimic’s the BOE with the fight against inflation is his priority. But if the government does offer some kind of relief to newly caught borrowers, this will undermine the Bank of England’s policy, at least for those mortgagees.

The focus on mortgage borrowing risks is a key component of the statement that anchored market expectations despite the 50bps increase. This provided an important counterweight and reinforced mortgage/indebtedness developments among the headline metrics, joining inflation and jobs data, that are a must-watch for calling the future policy path.

Source: Bank of England

From The TradersCommunity News Desk