The Bank of England raised interest rates a half point, saying more increases will be needed if signs of an inflationary spiral persist.
(Bloomberg) — The Bank of England raised interest rates a half point, saying more increases will be needed if signs of an inflationary spiral persist.
Policy makers led by Governor Andrew Bailey voted 7-2 to raise the benchmark lending rate to 4%, the highest since 2008 and continuing the quickest series of hikes in three decades. The majority said strong pay growth and an ongoing shortage of workers were feeding price pressures in the economy.
The decision came with a bleak outlook, with the central bank forecasting two years of falling output and supply potential in the economy a little more than half of its previous estimate. Bailey said that while inflation is likely to drop sharply, the risks that it remains above the 2% target are skewed more strongly to the upside than at any time on record.
“We have seen a turning of the corner, but it is very early days, and the risks are very large,” Bailey said at a press conference after the decision Thursday. He added that it’s “too soon to declare victory. Inflationary pressures are still there” and the BOE would have to be “absolutely sure” before shifting its stance.
Sterling fell as much as 0.9% to $1.2265 before paring slightly. UK bonds extended gains across the curve, sending the yield on 10-year notes as much 20 basis points lower, to 3.11%.
What Bloomberg Economics Says …
“The Bank of England’s latest policy decision and forecasts suggest rates are very close to peaking in the UK. We think a 25-basis-point hike is likely in March, though the risk of a pause has risen following its latest decision. By spring, inflation should be falling sharply while the labor market is likely to have loosened further. That makes it unlikely hikes extend beyond the first quarter of 2023. The stickiness of underlying inflation means we don’t see rate cuts until 2024.”
—Dan Hanson and Ana Andrade, Bloomberg Economics. Click for the REACT.
The BOE outlook is for a shorter and shallower recession than projected in November. The central bank estimated a 0.5% contraction this year. Bailey said that was “pretty similar” to the 0.6% drop the International Monetary Fund expects for the UK. “The difference is what happens thereafter,” he said. “They have growth picking up more rapidly than we do.”
That will pose a challenge to Prime Minister Rishi Sunak’s government, which must call an election by the start of 2025 with the economy still below its pre-pandemic level of output. The BOE also anticipates 500,000 more workers will lose their jobs during the slump, with inflation triggering a decline in real wages.
The BOE estimated of decline of almost 1% in gross domestic product across five quarters is smaller than the 2.9% fall over eight quarters predicted in November.
Despite the dismal backdrop, the BOE appeared to endorse the market view that rates will peak at around 4.5% in the coming months. The panel warned that “if there were to be evidence of more persistent pressure, then further tightening in monetary policy would be required.”
The market path currently anticipates rate cuts next year. In a sign that the end of the rate-rise cycle may be nearing, the BOE dropped its guidance that it would respond “forcefully” if necessary.
The range of views on the MPC reflected the challenge of fighting inflation, which is lingering near a 40-year high, and coping with a difficult economic outlook.
Silvana Tenreyro and Swati Dhingra voted to leave rates unchanged, saying the impact of past increases has yet to take full effect. Catherine Mann, who voted for a 75 basis-point increase last time, joined Bailey and the majority of MPC members in endorsing the half-point hike.
The BOE slashed its projection for the supply potential of the economy, noting Britain’s exit from the European Union was weighing on trade and that many workers have dropped out of the labor force.
In two years’ time on the market path for rates, consumer price inflation is below the 2% target. But policymakers cautioned against taking the forecast too definitively. “An inflation forecast that took into account these upside risks was judged to be much closer to the 2% target,” the committee said.
The BOE slashed its estimate of potential output, the economy’s growth speed limit, to 0.7% for the next three years – down from 0.9% in November and from 1.5% at its last “supply stock take” 15 months ago. Before the financial crisis, the trend rate was 2.5%, and in the decade to the pandemic was around 1.5%.
Bailey said the BOE is concerned about a drop in the number of people in the workforce, which is pushing up wages more quickly than officials had expected.
“There are two things going on here,” Bailey said. “The population is aging, that would have happened irrespective of Covid. The second thing, we observe is in the UK and this is not the case in other countries, what was a fall in participation in the early part of Covid has not reversed course. That’s what really makes the UK stands out really.”
The bank blamed a constellation of economic shocks, including Brexit, the pandemic and the energy prices. Specifically, it noted a shortage of workers, soft business investment and weak productivity.
The economic cost of Brexit hasn’t changed, but the BOE now believes more of the impact will come upfront. It reiterated that “the level of productivity would be around 3.25% lower in the long run” because the UK pulled out of the EU free-trade area.
–With assistance from Greg Ritchie, Joel Rinneby, Mark Evans, Zoe Schneeweiss, Tom Rees, Lucy White and Alice Gledhill.
(Updates market reaction and adds comment on IMF from fifth paragraph.)
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