Bank of England Raises Rates by 50 bps, Biggest Hike in 33 Years

The Bank of England has raised interest rates by 50 basis points – the biggest leap in many years. The move by the BoE follows the US Federal Reserve’s anticipated 75 bps rate increase. The Bank of England said it maintains resolve to fight inflation adding that fiscal policy remains an important variable.

According to the Bank, five members agreed with the 50 bps increase with one preferring a 75 bps increase and one voting for a 25 bps increase. The Bank Rate will now rise to 2.25%.  The increase in rates follows the US Federal Reserve’s decision to increase its benchmark rate by 75 bps which was largely expected.

The Bank of England’s Monetary Policy Committee (MPC) also voted unanimously to reduce the stock of purchased UK government bonds, financed by the issuance of central bank reserves, by £80 billion over the next twelve months, to a total of £758 billion, as was previously reviewed.

The rise in rates is due to the rapid increase in inflation, fueled in part by rising energy costs. The Bank referenced the impact on UK households as wage buying power declines.

The Bank of England stated:

“Uncertainty around the outlook for UK retail energy prices has nevertheless fallen, following the Government’s announcements of support measures including an Energy Price Guarantee. The Guarantee is likely to limit significantly further increases in CPI inflation, and reduce its volatility, while supporting aggregate private demand relative to the Committee’s August projections. An additional Growth Plan announcement is scheduled to take place shortly after this MPC meeting, which is expected to provide further fiscal support, and is likely to contain news that is material for the economic outlook. Once this announcement has been made, and as part of its November MPC round, the Committee will make a full assessment of the impact on demand and inflation from all these announcements, along with other news, and determine further implications for monetary policy.”

The Bank reported that 12-month CPI inflation declined slightly from 10.1% in July to 9.9% in August. The Bank expects the peak inflation to be lower than projected in the August report and under 11% in October. Inflation is predicted to remain above 10% over the following few months, before starting to fall back.

The MPC said it will take needed actions to return inflation to its 2% target.

CI received several comments on the Bank’s decision to raise rates by 50 bps. Shweta Singh, Senior Economist at Cardano, commented:

“Today’s 0.5% hike in Bank Rate by the Bank of England matched market expectations. With the vote split three ways the more hawkish dissenters preferred more forceful action, focusing their attention on the tightness of the UK labour market, the persistence of current inflation trends and upside risks. The trajectory of UK monetary policy remains in line with the similarly tighter policy settings being put in place by most of the world’s major central banks. Yesterday, the Federal Reserve hiked the effective Federal Funds rate by 0.75% and reiterated its intent to persevere with tighter monetary policy. Notably, Fed chair Powell remarked that he saw; “[no] painless way” to “get inflation behind us”. Both the Bank of England and the Federal Reserve are overtly prioritising the fight against inflation over support for growth in their domestic economies.”

Singh added that Chancellor Kwasi Kwarteng will soon review fiscal policy but the UK can expect difficult times ahead:

“An increasing budget deficit will require financing in a bond market that is still dominated by unattractive negative real yields and at a time when the Bank will be selling government bonds held on its balance sheet.  This contrasts with the situation in the US where Fed chair Powell has said that “positive real rates across the yield curve” are an important consideration for restrictive monetary policy Energy price caps and proposed tax cuts are going to preserve demand in the economy and, with a tight labour market, risk the further onset of a wage-price spiral. Also, the open-ended nature of the support promised could be problematical for the gilt market Sterling is biased toward further depreciation risking a fresh inflationary impulse because of the UK’s trade position. In this stagflationary environment, the only bright spot is that the FTSE (already one of the better performing global stock indices this year) is well supported by earnings that are flattered by a depreciating domestic currency.”

Singh noted that the Bank of England is continuing with its hawkish stance but not outpacing the US Fed. Both markets are expected to keep rising rates into 2023 but the Bank of England is not expected to open up a significant positive interest rate differential which may provide some respite from Sterling’s depreciation.

Douglas Grant, Group CEO at Manx Financial Group PLC, noted that this is the biggest rate increase in 33 years:

“Another rise in UK interest rates today is unavoidable. It continues to hit levels not seen for decades as inflation keeps on soaring, exacerbating the cost of living crisis. We believe that demand for working capital is set to climb to unprecedented levels as more businesses desperately require liquidity provisions to counteract rising interest rates, supply chain issues, increases in wages, and record energy price hikes.”

Grant said the cost of borrowing is poised to increase and many SMEs will struggle. He added that the UK government’s emergency intervention on energy costs for SMEs is great news for UK firms and shows that it is taking the challenges seriously.

“We do however believe that more needs to be done. Our research recently revealed that 22% of UK SMEs that needed external finance and/or capital over the last couple of years, were unable to access it. Indeed more than a quarter have had to stop or pause an area of their business because of a lack of finance. SMEs continue to struggle with accessing finance and worryingly, this lack of availability is costing them and the UK economy in terms of growth at a time when it is needed the most. The amount of growth that is being sacrificed is significant and will require new solutions which are designed to address this funding gap.”

Grant said the extension of the Recovery Loan Scheme (RLS Phase 3) was encouraging for UK firms. Grant said that a permanent loan scheme could be a “make or break” for many companies and hence the overall economy adding he hopes this becomes a reality.

 

 

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