Bank of England raises interest rates to 5%
Shweta Singh, Chief Economist at Cardano, shared her thoughts on the Bank of England’s latest interest rate decision on Thursday 22nd June.
“Today the Monetary Policy Committee (MPC) accelerated the pace of its hiking cycle raising Bank Rate by 0.50% to 5.00%. This more aggressive move had not been fully discounted by the market. UK government bond yields initially rallied suggesting the market was impressed with the Bank of England’s more forceful approach. Similarly, the premium for long-dated inflation protection declined meaningfully immediately after the decision. Although subsequent market movements have been more mixed, the Bank will take comfort in market reaction so far signaling a positive impact of today’s decision on their credibility.
Yesterday’s inflation release brought into sharp relief the problems facing the Bank as it continues to work towards brining inflation down to its 2% target rate.
Inflation outlook
Inflation and wage growth in the UK have continued to deliver upside surprises. Our own very bearish expectations of sticky inflation and tight labour market are beginning to be challenged. The key worry is underlying services inflation on the back of robust wage growth and a still tight labour market. These are key risks that the MPC are trying to get ahead of.
Markets are expecting a terminal Bank Rate of 6%. However, this is too high in our view, particularly given the front-loading of policy evident in today’s announcement.
The lagged effects of prior policy actions are still to be seen; the recent strengthening of sterling should help; the base effects of 2022’s energy price rises will impact too; and the surge in mortgage costs will start to hurt more acutely as the year progresses. We expect headline inflation to fall further through the remainder of this year, with the next step change likely in July as the energy price cap falls from £2500 to £2074. The key caveat is that any policy support from the government to address housing market stress could severely challenge the central bank’s ability to fight inflation and validate market pricing of the terminal rate and even push it higher.
In the future
Looking further into the future, we expect that monetary policy will have to remain in restrictive territory for some time before cuts could be considered. This is unlikely to be feasible until well into the second half of 2024, if not later.
The heightened interest rate environment also challenges the market’s UK growth forecasts for 2024. Expectations which are still too optimistic in our view. In the weaker growth environment that we expect, both in the UK and abroad, government bond allocations will prove to be a valuable diversifying offset to equity market investments for Pension Scheme investors’ growth portfolios.”
