A passageway near the Bank of England (BOE) in the City of London, UK on Thursday 18th March 2021.
Hollie Adams | Bloomberg | Getty Images
LONDON — The Bank of England hiked interest rates by 75 basis points on Thursday, the largest single hike since 1989, warning of a prolonged recession as policymakers sought to dampen market expectations for further aggressive monetary tightening.
The 75 basis point hike brings the policy rate to 3%, the eighth straight hike in the policy rate after the Monetary Policy Committee voted 7-2 in favor. One member voted for a 0.5 percentage point increase, while one preferred a 0.25 percentage point increase.
However, the bank appeared to question the market’s pricing of future rate hikes.
“The majority of the committee believes that should the economy develop broadly in line with the latest projections in the monetary policy report, further hikes in the policy rate may be needed to bring inflation back on target on a sustainable basis, albeit to a peak lower than what the financial markets have priced in,” the MPC said, providing the market with unusually specific guidance.
The MPC noted that its updated growth and inflation forecasts indicate a “very challenging” outlook for the UK economy as it looks to bring inflation back towards its 2% target.
UK GDP is forecast to contract by around 0.75% in the second half of 2022, reflecting pressure on real incomes from rising energy and traded goods prices.
Driven by rising market interest rate trends, growth is expected to slow further throughout 2023 and the first half of 2024 as “high energy prices and tighter financial conditions weigh on spending,” the bank said. Unemployment is expected to rise to 6.5% by 2025.
Economists had expected a less restrictive tone from the central bank after the change of government in Great Britain. The likely return of new Prime Minister Rishi Sunak to more conventional fiscal policy after the short and chaotic tenure of predecessor Liz Truss reassured markets and meant that monetary and fiscal policy no longer went in opposite directions.
However, inflation rose to 10.1% in September and is expected to rise to 11% in the fourth quarter, the bank said, while mortgage rates have risen sharply on higher interest rate expectations, further weighing on budgets.
“For the current November forecast, and in line with the government’s October 17 announcements, the MPC expects some fiscal support to persist beyond the current six-month Energy Price Guarantee (EPG) period, generating a stylized path for household energy prices into the next two years,” said the MPC.
“Such support would mechanically significantly limit further increases in the energy component of CPI inflation and reduce its volatility. However, by increasing aggregate private demand compared to August forecasts, the support could add to inflationary pressures in non-energy goods and services.”
Sterling fell 2% against the dollar after deciding to trade around $1.116, while UK government bond yields rose.
After its emergency bond-buying intervention last month averted a possible collapse of the UK pension fund market, the Bank of England revived its plan to sell gilts – which began on Tuesday.
‘Little choice’ to meet market expectations
All eyes will now turn to Treasury Secretary Jeremy Hunt’s November 17 finance statement, in which Hugh Gimber said, globally, the government “needs to strike a delicate balance between supporting the economy and having a credible medium-term debt-consolidation plan”. Market Strategist at JPMorgan Asset Management.
Gimber suggested the bank had “little choice” but to meet market expectations of a 75 basis point hike on Thursday.
“Such a large surge may seem unwarranted given signs that activity in the UK is already contracting, but there is little evidence so far that the slowdown is enough to tame inflation,” Gimber said.
“Vacancies continue to outpace job seekers and wage growth, at 6%, is well above levels consistent with the bank’s inflation target.”
However, he also hinted that against a backdrop of double-digit inflation and after aggressive action by the US Federal Reserve and European Central Bank, a more modest hike would have risked “rekindling questions about the bank’s credibility and further volatility in sterling markets.”
The Fed approved a fourth consecutive three-quarter-point hike on Wednesday, bringing its short-term borrowings to a target range of 3.75% to 4%, the highest since January 2008.
The ECB also implemented a 75 basis point hike last week, bringing its main benchmark to 1.5%, a level not seen since 2009.