Dan Kitwood | Getty Images News | Getty Images
LONDON – The Bank of England is expected to raise interest rates by 50 basis points on Thursday, the largest single increase since 1995.
Such a move would drive borrowing costs to 1.75% as the central bank battles rising inflation and would be the first half-point increase since it was made independent by the British government in 1997.
Inflation in the UK hit a new 40-year high of 9.4% in June as food and energy prices continued to rise, exacerbating the country’s historic cost of living crisis.
Bank of England Governor Andrew Bailey suggested in a hawkish speech on July 19 that the Monetary Policy Committee might consider a 50 basis point hike, vowing there would be no “ifs and buts” in the the Bank’s commitment to bring inflation back to its 2% target.
A Reuters poll conducted last week indicated that more than 70% of market participants now expect a half-point increase.
James Smith, a developed markets economist at ING, said that although economic data from the 25bp hike in June did not move the needle significantly, the MPC’s previous commitment to act “forcefully” to reducing inflation and market pricing by roughly 50 basis points at this stage means that policy makers are likely to engage in aggressive behavior.
“Even so, the window for further rate hikes appears to be closing. Markets have already reduced expectations for the bank rate” peak “from 3.5% to 2.9%, even if that still implies two further rate hikes of 50bps by December, plus a little more thereafter, ”Smith said.
“It still feels like a stretch. We set a peak for the bank rate at 2% (1.25% currently), which would mean just another 25 basis point rate hike in September before politicians stop tightening.”
He acknowledged that, in practice, this could be an underestimate and, depending on the signal sent by the Bank on Thursday, ING would not rule out an additional 25bps or at most 50bps of increases beyond.
Smith said the key points to watch out for in Thursday’s report would be whether the Bank continues to use the word “forcefully” and its predictions, which link market expectations to the Bank’s patterns and expected political trajectory.
If the forecasts indicate, as in previous iterations, an acceleration of unemployment and inflation well below the target in two or three years, the markets could infer a more accommodating message.
“Everyone takes that as a sign that they say ‘okay, if we were to follow what the markets expect, inflation will be below target’, which is their very indirect way of saying ‘we don’t need to increase. aggressively as the markets expect, “Smith told CNBC on Tuesday.
“I think it will repeat, I expect, and it should be taken as a small sign that perhaps we are nearing the end of the tightening cycle.”
A more aggressive approach to Thursday’s meeting would bring the Bank’s monetary tightening trajectory closer to the trend set by the US Federal Reserve and the European Central Bank, which implemented increases of 75 and 50 basis points, respectively, last month.
But while it can strengthen the Bank’s credibility in fighting inflation, the faster pace of tightening will exacerbate downside risks to the already slowing economy.
Berenberg senior economist Kallum Pickering said in a statement Monday that Governor Bailey is likely to take the MPC majority to nine if he supports a 50 basis point hike Thursday and predicts that with inflation likely still rising. Bank will increase by another 50 basis points in September.
“Thereafter, the outlook is uncertain. Inflation is likely to peak in October, when the energy price cap for households will rise again. Amid growing evidence that tighter monetary conditions are weighing on demand and ‘underlying inflation, we expect the BoE to rise an additional 25 basis points in November but stopped in December, ”Pickering said.
Berenberg expects the bank rate to hit 2.5% in November, up from 1.25% now, although Pickering said the risks of this call are skewed to the upside. He suggested that the BOE should be able to reverse some of the tightening during 2023 when inflation starts to roll over and is likely to reduce the bank rate by 50 basis points next year with a further reduction of 50 basis points in 2024. .
Increased ceiling on the price of energy
UK energy regulator Ofgem has raised its energy price cap by 54% since April to cope with rising global costs, but is expected to increase more in October, with annual energy bills forecast for households which will exceed £ 3,600 ($ 4,396).
Barclays has historically been cautious on bank rates, placing a lot of faith in the MPC’s “early and gradual” strategy. However, UK chief economist Fabrice Montagne told CNBC in an email last week that it is now possible for policy makers to act “forcefully” as energy prices continue to rise.
“In particular, rising energy prices are fueling our Ofgem price cap forecast and will force the BoE to revise its inflation forecast once again. Higher inflation even longer is the kind of scenario that scares central banks due to increased persistence and spillover risks, “he said.
The British banking giant now expects a 50 basis point hike on Tuesday followed by 25 basis points in September and then “status quo” at 2%.