BoE Ploughs Ahead With Bigger Rate Hike Despite Recession Fears

 

- Bank lifts benchmark interest rate a half a point to 1.75%

- Cost of not hiking forcefully too high a risk - Bailey

- MPC says job is to get inflation back down to 2%

- Higher energy prices expected to push inflation to 13%

- August MPR projects five quarters of recession

- Committee to vote on start of gilt sales in September

 

By Harry Daniels

LiveSquawk News

@HarryDaniels71

 

 

04 August 2022 | 13:30 GMT

 

LONDON – The Bank of England’s Monetary Policy Committee increased its main rate by the most in nearly 40 years whilst warning of an unavoidable recession on the horizon, appearing to place more weight on the current fight with inflation over supporting growth.

 

The committee voted by an 8-1 majority to lift rates by half a percentage point to 1.75%, with one dissenter, Silvana Tenreyro, preferring to hike by just 25 basis points. The move was in line with the most recent market consensus and puts the benchmark at its highest level since January 2009.

 

The quarterly Monetary Policy Report summary noted that inflationary pressures in the United Kingdom and the rest of Europe had intensified significantly since the May report and the MPC’s previous meeting. 

 

Bank Governor Andrew Bailey said the committee was conscious of the squeeze on household incomes due to the rise in energy prices, and he acknowledged that UK GDP growth was slowing. However, he said policymakers chose to move by a larger-than-normal amount in a bid to dampen embedded inflation expectations.

 

James Smith, developed markets economist at ING, said the fact that the bank is stepping up the pace of rate hikes while also forecasting a meaningful recession shows just how worried it is that worker shortages and supply issues could keep inflation elevated even as the economy weakens. “In other words, it’s the supply side of the economy – much more so than what’s happening with demand – that will heavily determine when and after how many more hikes the BoE will stop tightening.”

 

Updated staff projections
Source: BoE MPR

August’s MPR said central projection was for consumer prices to surge further over the remainder of the year before falling in 2023. “Inflation is expected to rise more than forecast in the May report, from 9.4% in June to just over 13% in 2022 Q4, and to remain at very elevated levels throughout much of 2023, before falling to the 2% target two years ahead.” It blamed “persistently high gas and other commodity prices” for continued upward pressure on consumer costs in the near-term as well as the expected lifting of the energy price cap in October.

 

On growth, the bank downgraded the outlook from its May forecast. It said real household post-tax income is projected to fall sharply in 2022 and 2023, while consumption growth will turn negative.

 

“Underlying quarterly UK GDP growth slowed from 0.9% in 2022 Q1 to 0.5% in 2022 Q2 and was expected to slow further to 0.2% in Q3,” the bank said. “This reflects the adverse impact of the very sharp increases in energy, non-energy commodities and tradable goods prices on UK household real incomes and spending.”

 

In baseline projections, 2022 GDP growth is expected to fall 1.5% in 2023 and 0.25% in 2024.

 

On the labour market, staff noted that it remained tight, noting that situation may loosen only slowly in response to falling demand, unemployment is expected to rise from 2023.

 

Bank officials added the caveat that the risks around the MPC’s projections from both external and domestic factors were “exceptionally large at present.”

 

Future path for rates

ING’s Smith said, “Given that only one official dissented on the decision, and the fact that the bank reiterated its willingness to act ‘forcefully’ to curb inflation, we think there's a strong possibility of another 50bp hike in September – particularly if that’s what both the Fed and ECB end up doing too.”

 

TD Securities analysts highlighted the fact that changes to the MPC's guidance were significant, and while the committee was broadly on board with today's 50bps hike, it was increasingly clear that some members thought the end of the road was near for rate hikes. “After six consecutive hikes, the bank rate is likely now around its long-run neutral rate (though below its contemporaneous neutral rate). Rates are likely to continue rising, but there is now even greater uncertainty around future hikes.”

 

The team left its forecast for the bank rate unchanged: “We expect 25bp hikes at both the September and November meetings, reaching a terminal rate of 2.25%”

 

As expected, the bank gave an update on its plan to sell its UK government bond holdings, bought via its asset purchase facility (otherwise known as quantitative tightening). It said that based on internal analysis, “the committee is provisionally minded to commence gilt sales shortly after its September meeting, subject to economic and market conditions being judged appropriate and to a confirmatory vote at that meeting.”

 

Some analysts expressed concerns that in anticipation of the sales, government borrowing costs have already started to tick up and could cause unintended consequences.

 

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