Bank of England raises rates by 50 bps to 5%, highest since 2008
The BoE said that there had been “significant” news suggesting British inflation would take longer to fall and that “second-round effects” in domestic price and wage developments generated by external cost shocks were likely to take longer to unwind than they did to emerge.
The rate hike comes amid a challenging economic environment for Britain, which has been hit by the shock of Brexit, the COVID-19 pandemic and the surge in gas prices caused by Russia’s invasion of Ukraine. However, the BoE said that the economy had dodged a widely expected recession so far in 2023 and that growth prospects had improved slightly since its last meeting in May.
The BoE’s decision was far from a foregone conclusion after the March MPC meeting when the committee said it would continue to monitor for “evidence of more persistent [inflationary] pressures” before raising interest rates again. But in the past month, official data showed inflation in March was running at 10.1 per cent, well above the BoE’s forecast made in February when it expected an easing to 9.2 per cent. Combined with a pick-up in wage pressures and stronger economic data, economists believe that evidence threshold has been reached.
The expected rate increase would be the 12th successive boost by the BoE since it started raising rates in December 2021. It comes in the wake of similar moves by the US Federal Reserve and European Central Bank. Economists and the markets almost universally expected a quarter of a percentage point increase from 4.25 per cent to 4.5 per cent. The rise to 5 per cent caught many off guard and sent the pound sterling higher against other major currencies.
The BoE also updated its economic forecasts on Thursday, which showed a higher than expected inflation rate for March but lower than anticipated energy prices for the rest of the year. The BoE said that inflation would peak at around 11 per cent in the second quarter of 2023 before falling back towards its 2 per cent target by mid-2024. The BoE also revised up its growth forecast for 2023 from 3.4 per cent to 3.7 per cent and for 2024 from 3.7 per cent to 4 per cent.
The BoE’s governor Andrew Bailey, in a regular letter to British finance minister Jeremy Hunt alongside the decision, reiterated that the MPC would do what was necessary to return inflation to the 2 per cent target sustainably in the medium term. He also warned that there were still significant uncertainties and risks around the outlook, especially related to the evolution of the pandemic and geopolitical tensions.
The BoE’s decision was not unanimous, however. Two members of the MPC, Silvana Tenreyro and Swati Dhingra, opposed the rate rise - as they have all others this year - saying that much of the impact of past tightening had yet to be felt, and forward-looking indicators pointed to steep falls in inflation and wage growth ahead.
The markets are now pricing in further rate hikes by the BoE this year, with expectations that the Bank Rate will peak at around 6 per cent by the end of 2023. By contrast, economists polled by Reuters last week saw a 5 per cent peak.
The BoE’s decision has implications for borrowers and savers in Britain. The cost of new mortgages has risen sharply in recent days as lenders anticipated higher interest rates. The average two-year fixed-rate mortgage deal has increased from 1.99 per cent at the start of June to 2.18 per cent on Thursday. On a £200,000 mortgage over 25 years, this would add £24 a month to repayments. Savers, on the other hand, may benefit from higher returns on their deposits, although banks and building societies have been slow to pass on previous rate increases to customers.
The BoE’s decision also has implications for the global economy, as it signals that central banks are becoming more hawkish in their response to rising inflation pressures. The BoE is the third major central bank to raise interest rates this year, following the US Federal Reserve and the European Central Bank. Other central banks, such as the Bank of Canada and the Reserve Bank of Australia, are also expected to tighten monetary policy in the coming months. The tightening cycle could pose challenges for emerging markets, especially those with high debt levels and external vulnerabilities, as they face higher borrowing costs and capital outflows.
The BoE’s decision marks a significant shift in its monetary policy stance, which has been ultra-loose since the global financial crisis of 2008. The BoE has cut interest rates to record lows, expanded its balance sheet through quantitative easing and provided forward guidance to support the economy through various shocks. Now, the BoE is leading the way in reversing some of these stimulus measures as it tries to contain inflation and anchor expectations. The question is whether the BoE has acted too late or too soon, and whether it will be able to strike the right balance between supporting growth and controlling inflation in a highly uncertain environment.