Thursday’s interest rate increase by the Bank of England is anticipated to be its biggest one-time increase since 1995 and will increase rates by a total of 50 basis points.
It would be the first half-point increase since the central bank’s 1997 separation from the British government and would raise borrowing prices to 1.75 percent as it tackles increasing inflation.
Inflation in the United Kingdom increased to a record 40-year high of 9.4% in June as food and energy costs continued to rise, worsening the nation’s chronic cost-of-living crisis.
In a hawkish speech on July 19, Bank of England Governor Andrew Bailey hinted that the Monetary Policy Committee might take into account a 50 basis point increase, pledging that there would be “no ifs or buts” in the Bank’s commitment to getting inflation back to its 2 percent objective.
Over 70% of market players currently expect a half-point increase, according to a Reuters poll conducted over the previous week.
The MPC previously pledged to act “forcefully” to bring inflation down, and the market is currently more-or-less pricing in 50 basis points at this point, James Smith, developed markets economist at ING, said that even though the economic data since June’s 25 basis point hike had not significantly changed the situation, policymakers are likely to err on the side of aggression.
“Even so, the window for further rate hikes feels like it’s closing. Markets have already pared back expectations for ‘peak’ Bank Rate from 3.5% to 2.9%, though that still implies two further 50bp rate hikes by December, plus a little more thereafter,” Smith said.
“That still feels like a stretch. We’ve been penciling in a peak for Bank Rate at 2% (1.25% currently), which would mean just one more 25bp rate hike in September before policymakers stop tightening.”
He conceded that, in reality, this might be an underestimation and that, depending on the signal the Bank delivers on Thursday, ING wouldn’t rule out further rate increases of at least 50 basis points and at most another 25 basis points.
Smith stated that the most important things to look out for in Thursday’s report would be the Bank’s forecasts, which include market expectations into the Bank’s models and anticipated policy trajectory, as well as whether the Bank continues to employ the word “forcefully.”
If the forecasts show, as in prior versions, an acceleration of unemployment and inflation well below goal in two to three years, markets may interpret this as sending a more dovish message.
“Everybody takes that as a sign of them saying ‘okay, well if we were to follow through with what markets are expecting, then inflation is going to be below target,’ which is their very indirect way of saying ‘we don’t need to hike as aggressively as markets expect,’” Smith told.
“I think that will be repeated, I would expect, and that should be taken as a bit of a sign maybe that we’re nearing the end of the tightening cycle.”
Worrying about growth
If the Bank adopted a more aggressive stance at its meeting on Thursday, its monetary tightening trajectory would be closer to the trend established by the European Central Bank and the U.S. Federal Reserve, which imposed 75 and 50 basis point increases, respectively, last month.
However, the higher rate of tightening may increase downside risks to the already-slowing economy, even though it may strengthen the Bank’s credibility in its fight against inflation.
In a note published on Monday, Berenberg Senior Economist Kallum Pickering predicted that if Governor Bailey supports a 50 basis point hike on Thursday, he will likely win over a majority of the nine-member MPC and that the Bank will raise interest rates by an additional 50 basis points in September because inflation is likely to continue rising.
“Thereafter, the outlook is uncertain. Inflation will likely peak in October when the household energy price cap increases again. Amid growing evidence that tighter monetary conditions are weighing on demand and underlying inflation, we expect the BoE to hike by a further 25bp in November but pause in December,” Pickering said.
Although Pickering noted that the risks to this prediction are skewed to the upside, Berenberg anticipates that the bank rate will increase to 2.5 percent in November from its current level of 1.25 percent. As inflation starts to level off, he said that the BOE should be able to reverse some of the tightening throughout 2023. He also predicted that the BOE will likely decrease the bank rate by 50 basis points in 2019 and another 50 basis points in 2024.
An increase in energy rates
The energy price cap was raised by 54 percent by the British energy regulator Ofgem from April to account for rising worldwide costs, but it is anticipated to increase much more in October, when annual family energy expenses are anticipated to exceed £3,600 ($4,396).
Barclays has a history of being conservative when it comes to bank rates and has great confidence in the MPC’s “early and gradual” approach. However, with energy prices continuing to rise, chief U.K. economist Fabrice Montagne wrote in an email to CNBC last week that there is now a case for policymakers to act “forcefully.”
“In particular, surging energy prices are feeding into our forecast of the Ofgem price cap and will force the BoE to revise up its inflation forecast yet again. Higher inflation for even longer is the kind of scenario that spooks central banks because of higher risks of persistence and spillovers,” he said.
The largest British bank now anticipates a 50 basis point increase on Tuesday, followed by a 25 basis point increase in September and “status quo” at 2 percent after that.