BOE Raises Rates With UK Likely to Avoid Recession for Now

The Bank of England pushed ahead with another interest rate increase despite turmoil in the banking sector, predicting the UK economy will avoid a recession for now and that inflation remains a risk.

(Bloomberg) — The Bank of England pushed ahead with another interest rate increase despite turmoil in the banking sector, predicting the UK economy will avoid a recession for now and that inflation remains a risk.

The central bank raised its benchmark lending rate as expected by a quarter point to 4.25%, the highest since 2008, and left the door open to further increases if inflation persists. Policy makers voted 7-2 for the hike, with none of the BOE’s officials joined the dissent.

Governor Andrew Bailey and his colleagues are seeking to keep a lid on soaring prices at a time when turmoil in financial markets is threatening to upend the outlook for the economy. The BOE brushed aside concerns about the banking system after the rescue of two major institutions abroad, suggesting policy makers see inflation as the main priority.

“If there were to be evidence of more persistent pressures, then further tightening in monetary policy would be required,” minutes of the meeting released Thursday said, a guidance that’s in step with what the BOE said in February.

The remarks temper the thought that the BOE is ready to call a halt to its quickest tightening spree in three decades. Investors last week had started to bet on a pause for rate rises but quickly reversed those positions after an unexpected jump in inflation data released Wednesday.

“Price stability is an essential pre-requisite to achieve this objective in all parts of the United Kingdom and sectors of the economy,” Bailey wrote in a letter to the Treasury published alongside the decision. “The committee will continue to act as necessary to ensure that CPI inflation returns to the 2% target.”

The pound rose, and investors priced in more certainty of at least one more rate hike later this year. The UK currency rose 0.3% to $1.2309 compared to around 1.2305 before the decision.

Minutes of the meeting provided no new commentary on the turmoil that engulfed Credit Suisse Group AG and Silicon Valley Bank. The BOE’s Financial Policy Committee told officials that the UK banking system remains well capitalized and “resilient” to absorb shocks.

That strengthened the sense that the BOE will operate its monetary policy independently of the moves to clear up trouble in the banking system. Bailey may address the matter next week in a speech scheduled for Monday and an appearance in Parliament on Tuesday. The BOE’s 11th straight increase follows hikes at the US Federal Reserve and European Central Bank, with rate-setters around the globe saying their priority is the battle to tame inflation.

“It is possible that recent concerns in the global banking sector will serve to tighten credit conditions, but that is not guaranteed,” said Karen Ward, chief market strategist EMEA at J.P. Morgan Asset Management. “As with the ECB last week and Fed last night, the Bank of England acted on the information it had today, which is that the economy is still resilient, inflation is uncomfortably high and broadening, and wage growth is at a level that is inconsistent with a 2% inflation target.”

What Bloomberg Economics Says …

“The Bank of England’s March hike looks like it could be the last of this cycle. As was the case in February, the committee’s guidance suggests it needs to be surprised by the persistence of inflation between now and its next meeting to hike again. We doubt it will be and expect a lengthy pause to begin in May. The risk to our view continues to be that underlying price pressure stemming from the labor market remains stubborn.”

—Dan Hanson and Jamie Rush, Bloomberg Economics. Click for the REACT.

Vivek Paul, chief UK investment strategist at BlackRock Investment Institute, said, “Central banks will not ride to the rescue with rate cuts at the first sign of growth concerns, as we’ve been used to for a generation.” 

For the majority of the nine-member Monetary Policy Committee, inflation was 0.6% stronger than anticipated last month and the labor market remained tight enough to fan concerns about a wage-price spiral. They also noted that the economy was much stronger than anticipated last month, so much that officials no longer expect a contraction in the second quarter as they had predicted in February.

“The stronger domestic and global outlook for demand was also being driven by factors over and above the weaker path of energy prices,” minutes of the meeting said.

Silvana Tenreyro and Swati Dhingra voted for no change in rates, arguing that previous hikes are still feeding through to the economy. They said the current policy rate is restrictive enough that the BOE may soon have to reverse those moves.

The BOE said the global and UK economies have been more resilient than expected. 

It expects GDP to rise slightly in the second quarter, a sharp upgrade from the 0.4% decline it projected last month. Budget stimulus announced by Chancellor of the Exchequer Jeremy Hunt last week will boost GDP by 0.3% over the coming years. 

While the BOE did upgrade its growth outlook for coming months, it didn’t comment on its forecasts for the second half of the year where in February it pencilled in two negative quarters.

While inflation has “surprised significantly on the upside,” it still expects price growth to cool sharply in the coming months. The extension of more generous government energy support and continued falls in wholesale gas prices will drag down inflation from double digits, the BOE said.

In an exchange of letters with the BOE governor, which is required every quarter that inflation is above target, Hunt said: “The government’s commitment to the 2% target, and the independence of the Bank, remains absolute. I know that the MPC will take the necessary steps to achieve this.”

He added that he recognized “inflation has increasingly been driven by more domestic factors” which “stem from a tight labor market, putting upward pressure on wages.”

He said back-to-work measures that he announced in this month’s budget, including extra childcare support, were designed to loosen the tight labor conditions.

The policy makers said the labor market remains tight but they also saw signs that wage growth will ease more quickly than previously thought. Unemployment is no longer expected to begin increasing in the second quarter.

Read more:

  • Fed Opts for Hike-and-See in Gamble Crisis Will Stay Contained
  • Lagarde Vows ‘Robust’ Policy With ECB Ready to Act as Needed
  • UK Inflation Surprise is the Largest Since 2009 Crisis: Chart

–With assistance from Lucy White, Greg Ritchie and Philip Aldrick.

(Updates with comment from Bailey and Hunt.)

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