The Bank of England raised its benchmark lending rate to the highest level since 2008, with Governor Andrew Bailey saying further increases may be needed to “stay to course” in the fight to slow inflation.
(Bloomberg) — The Bank of England raised its benchmark lending rate to the highest level since 2008, with Governor Andrew Bailey saying further increases may be needed to “stay to course” in the fight to slow inflation.
The UK central bank lifted its key rate a quarter point as expected to 4.5%, with two of the nine-member Monetary Policy Committee voting for no change. The majority of the panel said “repeated surprises” pointing to the resilience of the economy have added to price pressures and required action.
“Low and stable inflation is the foundation of a healthy economy,” Bailey told reporters in London after the decision was announced. “And we have to stay the course to make sure inflation falls back to the 2% target.”
The pound trimmed losses and gilts pared gains after decision. Money-market traders added to bets on the terminal rate, pricing it at 4.95% by September, compared to 4.90% before the decision.
By the end of 2023, inflation is forecast to have fallen to 5.1%. While above the 3.9% previously forecast, it would be enough for Prime Minister Rishi Sunak to meet his pledge to cut inflation in half this year. Higher mortgage costs are also bumping up rental prices, as landlords demand higher sums from tenants and some look to sell their properties due to rising expenses.
The Labour party lashed out at Sunak on Wednesday, blaming him for higher mortgage costs due to his perceived failure to boost growth in the economy post-pandemic. The cost-of-living crisis is expected to become major issues in the general election widely expected next year.
Officials led by Bailey also delivered the biggest upgrade to growth projections since the BOE gained independence in 1997, erasing a recession previously forecast and anticipating the real economy will be 2.25% bigger by mid-2026 than it thought in February.
“The MPC has again been driven to raise rates by stubbornly high inflation, ongoing strength in wage growth, and better-than-expected activity,” said Anna Leach, deputy chief economist for Confederation of British Industry. With inflation having been at or above 9% for a full year, the Bank are rightly concerned that higher inflation could become entrenched.”
The latest rate decision continues the quickest round of increases in four decades, a move the BOE expects to weigh more heavily on households and businesses in the coming months. The BOE is fighting double-digit price increases that remain stronger than the forces buffeting the US and Eurozone.
“If there were to be evidence of more persistent price pressures, then further tightening in monetary policy would be required,” the BOE said Thursday in minutes of the decision. That language was unchanged from March’s meeting, which at the time was interpreted as opening the door to a pause in the hiking cycle.
Inflation, economic growth and surveys about the labor market have all surprised on the upside in recent weeks. That prompted investors to price in more rate hikes through the summer to as much as 5% even as the US Federal Reserve signaled the possibility of a pause.
What Our Economists Say…
“The Bank of England’s decision to leave its policy guidance unchanged in May suggests the central bank is reticent to signal it’s getting closer to pause its hiking cycle. While the strong near-term outlook for annual CPI has reduced the chance of upside data surprises in coming months, we still think there is plenty of scope for the wage and core inflation data to show further signs of persistence, leaving us comfortable with our expectation for a final hike in June.”
— Dan Hanson and Ana Andrade
Officials expect Chancellor of the Exchequer Jeremy Hunt’s budget measures outlined on March 15 to add 0.5% to gross domestic product, above the 0.3% assumed in February.
“Although it is good news that the Bank of England is no longer forecasting recession, today’s interest rate rise will obviously be very disappointing for families with mortgages,” Hunt said in a statement. “But unless we tackle rising prices, the cost of living crisis will only carry on – which is why we need to be resolute in sticking to our plan to halve inflation by the end of the year.”
The economy is expected to stagnate in the first and second quarters of this year when factoring in the impact of strikes and the bank holiday for King Charles III’s coronation, but it will grow around 0.2% per quarter on an underlying basis.
The improvement was mainly due to lower energy prices, along with fiscal stimulus and lower unemployment boosting consumer confidence and spending.
Officials also were optimistic that the UK would be spared the worst of the banking crisis hitting the US, where authorities arranged a hasty buyout for First Republic Bancorp and rescue for Silicon Valley Bank. The tremors in the banking sector are expected to shave 0.25% of US growth, according to the BOE’s forecasts.
While the BOE was forced to intervene on with the UK unit of SVB, that didn’t appear to influence Thursday’s rate decision.
“The impact of recent global banking sector developments on domestic credit conditions and hence UK GDP was expected to be small,” minutes of the decision said.
But higher food price inflation are offsetting some of the optimism, the BOE noted, as it emphasized the unprecedented nature of trade shock from the war in Ukraine and said it was unsure how long it would take for improvements in trade to feed through into lower prices.
“As headline inflation falls, these second-round effects are unlikely to go away as quickly as they appeared,” Bailey said. “We think the unwinding of second-round effects may take longer than it did for them to emerge.”
Silvana Tenreyro and Swati Dhingra for a third meeting voted in the minority for no change in rates. They anticipate a sharp drop in inflation this year will alleviate the persistent elements of price pressures and were concerned that “sizable impacts from past rate increases were still to come through.” They said increasingly “restrictive” policy may bring forward the point at which rates must be cut.
“I think they should now pause,” said Mike Bell, global market strategist at J.P. Morgan Asset Management. “They can always hike rates further later on if needs be to get the job done but if they keep raising rates before the effect of their prior tightening has been felt, they risk going too far and doing more damage to the economy than is required to bring inflation back to target.”
–With assistance from Andrew Atkinson, Constantine Courcoulas, James Hirai, Greg Ritchie and Tom Rees.
(Updates with Bailey comments in third paragraph.)
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