As expected, the Bank of England (BoE) hiked 25bp to 0.50% this week. However, no less than four monetary policy committee (MPC) members voted for a 50bp hike.
They also signalled another rate hike in the near-ish term, saying that “if the economy develops broadly in line with the February Report central projections, some further modest tightening in monetary policy is likely to be appropriate in the coming months” (my italics).
As expected, the BoE also decided to stop reinvesting maturing assets (passive quantitative tightening, or QT), confirming that they would not reinvest the £27.9 cash flow from the redemption of the March 2022 gilt that they hold. They have also decided to start selling corporate bonds – with the full stock of corporate bond assets unwound by 2023.
Tough on consumers
This UK rate rise comes against the backdrop of high inflation, tightening fiscal policy and alongside prospects of steeply rising utility bills in April after the announcement of the 54% increase in the Ofgem price cap (albeit with some offsetting government policy changes). After that Ofgem announcement, Consumer Price Index (CPI) inflation currently looks likely to me to peak at 7% year-on-year or a bit above in April, with Retail Price Index (RPI) inflation a bit above 8.5%.
The outlook for household real disposable incomes continues to look challenging therefore and this was underscored by the frankly downbeat forecasts for the real economy published by the BoE. They are not hiking rates because the economic outlook is becoming more and more positive, but because the inflation picture is becoming more worrying.
All that said, there was some strong implicit pushback against the market interest rate profile, with the MPC signalling that the market has too much/too fast priced in for monetary policy tightening. That was reflected in their inflation forecast being below the 2% target at their forecast horizon once that market interest rate path was incorporated. The market-implied path for rates they used has the policy rate at 1.5% by mid-2023. In three years’ time, they forecast inflation well below target at only 1.6%.
If energy prices fully followed forward curves, they’d expect CPI inflation three quarters of a percentage point below the 2% target at both the 2 and 3 year horizon… They see the balance of risk to their inflation forecast as balanced too (rather than to the upside). Plus, in their constant rate profile (i.e. where they model what would happen if rates stayed at 0.50%) they only have CPI inflation slightly above target in three years’ time at 2.1%Y.
The BoE’s forecasts for GDP growth remain on the downbeat side (mainly reflecting a hit to real consumer spending from higher energy and goods prices).
Why did a 25bp hike win out?
Those arguing for a 25bp hike rather than 50bp “recognised the risks from the possibility of stronger domestic wage and price pressures in the near term”, but:
- Felt that needed to be balanced against the risk of inflation falling faster than expected “if energy and other tradable goods prices followed a lower path than in the MPC’s central projection”.
- They also worried that “a larger increase at this meeting could have an outsized impact on expectations for the further path of policy”.
Another rate rise looks likely within a quarter – likely at the May meeting, but potentially in March, followed in my view by another 25bp rate rise a few months later while inflation is still relatively high. However, given the building challenges to the consumer, at that point the pace of rate rises seems likely to slow down significantly and resemble the profile I had previously pencilled in (no further hikes in 2022 once rates reach 1% then roughly one 25bp rate rise a year until rates reach around 1.75%). However, there are significant uncertainties around that profile and much will depend on the path of pay growth and inflation expectations from here.
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