LONDON – FEBRUARY 03: Bank of England Governor Andrew Bailey leaves after a press conference at the Bank of England on February 3, 2022 in London, England. The bank is expected to hike interest rates for a fifth consecutive day on Thursday but faces a difficult balancing act between supporting growth and curbing inflation.
Dan Kitwood | News from Getty Images | Getty Images
LONDON — The Bank of England is widely expected to hike interest rates by 50 basis points on Thursday, the largest single hike since 1995.
Such a move would push borrowing costs to 1.75% as the central bank battles rising inflation, and would be the first half-point hike since independence from the UK government in 1997.
UK inflation 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 a hawkish speech on July 19, suggested that the Monetary Policy Committee might consider a 50 basis point hike and vowed there were “no ifs or buts” in the commitment of the Bank would give inflation back to its 2% target.
A Reuters poll conducted last week showed that over 70% of market participants now expect a half-point hike.
James Smith, developed markets economist at ING, said that although economic data had not moved the needle significantly since rising 25 basis points in June, the MPC’s earlier pledge to act “briskly” was designed to control inflation and the market more or less lower. Pricing 50bps at this point means policymakers are likely to make an aggressive mistake.
“Nevertheless, the window for further rate hikes seems to be closing. Markets have already cut expectations for the ‘top’ policy rate from 3.5% to 2.9%, although that still means two more 50 basis point rate hikes through December plus a little more thereafter,” Smith said.
“It still feels like a track. We have a peak interest rate at 2% (currently 1.25%), which would mean just another 25 basis point rate hike in September before policymakers stop tightening.”
He acknowledged that in practice this could be an underestimate and depending on the signal the bank sends on Thursday, ING wouldn’t rule out further hikes worth 25 basis points or at most 50 basis points beyond that.
Smith said the key points to look for in Thursday’s report are whether the bank continues to use the word “strongly” and its forecasts, which incorporate market expectations into the bank’s models and expected policy stance.
If, as in previous iterations, the forecasts show unemployment and inflation accelerating well below target in two to three years, markets could glean a more dovish message.
“Everyone takes that as a sign that they’re saying, ‘Okay, well, if we did what the markets are expecting, inflation will be below target,’ which is their very indirect way of saying, ‘that we don’t need to ‘rise as aggressively as markets expect,'” Smith told CNBC on Tuesday.
“I think that will repeat itself, I would expect, and perhaps that should be taken as a small sign that we are nearing the end of the tightening cycle.”
A more aggressive approach at Thursday’s meeting would bring the bank’s monetary tightening path closer to the trend set by the US Federal Reserve and European Central Bank, which made hikes of 75 and 50 basis points, respectively, over the past month.
But while it may bolster the bank’s credibility in fighting inflation, the faster pace of tightening will exacerbate downside risks to the already flagging economy.
Kallum Pickering, Berenberg’s senior economist, said in a note on Monday that Gov. Bailey is likely to carry the majority of the nine-member MPC if he backs a 50 basis-point hike on Thursday, forecasting the bank to trade at a likely still-rising rate Inflation will increase by another 50 basis points in September.
“After that, the prospects are uncertain. Inflation is likely to peak in October when the household energy price ceiling rises again. With increasing signs that tighter monetary conditions are weighing on demand and underlying inflation, we expect the BoE to rise another 25 basis points in November but pause in December,” Pickering said.
Berenberg expects bank rates to hit 2.5% in November, up from 1.25% currently, although Pickering said risks to that call are to the upside. He suggested that the BOE should be able to reverse some of the tightening later in 2023 when inflation starts to rise and is likely to cut interest rates by 50 basis points next year, with a further 50 basis point cut in 2024.
Increase in the energy price cap
Britain’s energy regulator Ofgem has raised energy price caps by 54% from April to reflect rising global costs, but it’s expected to rise even more sharply in October, with households’ annual energy bills expected to hit £3,600 ($4,396) will exceed.
Barclays has historically been cautious on bank rates and has high confidence in the MPC’s “early and progressive” strategy. However, the UK’s chief economist, Fabrice Montagne, told CNBC in an email last week that policymakers should now act “with vigour” as energy prices continue to soar.
“Rising energy prices in particular feed into our Ofgem price cap forecast and will force the BoE to revise its inflation forecast yet again. Even longer higher inflation is the kind of scenario that spooks central banks due to higher risk persistence and spillovers,” he said.
The UK banking giant now expects a 50 basis point hike on Tuesday, followed by 25 basis points in September and the ‘status quo’ at 2%.