- Shift to smaller rate hikes could signal the end of the tightening cycle
- Economists were split on whether BoE would deliver another ‘double hike’
The Bank of England delivered a 0.25 percentage point hike this afternoon to take the base rate to 5.25 per cent, the highest level since 2008, despite signs that UK inflation is on a decisively downward path.
Positive inflation figures last month saw traders revise interest rate expectations downwards, and market pricing implied a smaller hike from the Bank this week compared to June's 0.5 point hike. Six members voted for 0.25 per cent, two for the more significant rise of 0.5 per cent, and one for no rise whatsoever.
Today’s decision was accompanied by a quarterly Monetary Policy Report, which set out forecasts for real GDP, unemployment and inflation. The Bank remains concerned about the persistence of services price inflation, noting that it is "projected to remain elevated at close to its current rate in the near term”. Though policymakers expect inflation to fall to 5 per cent by the end of the year, they do not expect it to return to the 2 per cent target until the second quarter of 2025.
The Bank also downgraded its growth forecast for 2024 and 2025 to 0.5 per cent and 0.25 per cent, with the UK economy narrowly avoiding a recession. On Friday, it was announced that US economist Ben Bernanke would lead a review into forecasts and their role in policymaking “in light of major economic shocks”.
Today’s announcement saw the BoE move in step with the US and European central banks, who both increased rates by 25 basis points last week. Though UK inflation is now falling, it remains high by international standards. Markets and many economists still expect UK policymakers to raise rates by a further 0.5 points to a peak of just over 5.75 per cent by the spring.
Policymakers noted today that “the current stance of policy is restrictive”, but implied that interest rates could remain elevated for some time. The Bank said that “the monetary policy committee will ensure that Bank Rate is sufficiently restrictive for sufficiently long to return inflation to the 2 per cent target sustainably in the medium term, in line with its remit”.
Mike Riddell, head of macro unconstrained at Allianz Global Investors, said that traders “may well be right”, but warned that low confidence and faltering house prices suggest that higher interest rates are already beginning to feed through to the UK economy.
This means that interest rates could be cut more quickly than markets expect. “If the BoE succeeds in killing growth and driving inflation lower, and we think they will succeed, then the BoE should be in a position to cut rates again next year”, he said.
But the path down to the target may not be smooth. Bank of America analysts warned that “we expect core inflation to slow gradually, reflecting our view that the UK has an entrenched inflation problem”. They added that the UK’s current rate of wage growth was “incompatible with a sustainable return of inflation to target within the next couple of years”. As a result, they do not expect rate cuts until the first quarter of 2025. The end of the tightening cycle may be coming into view, but rate cuts still look far more distant.
Despite the 0.25 point increase, economists were split in their predictions in the build up, with several suggesting that a second ‘super 0.5 point hike’ would have helped to bolster the BoE’s credibility.
Speaking before the release, BNY Mellon market strategist Geoff Yu, said a 50 basis point move was necessary to "consolidate recent gains in the re-anchoring of inflation and inflation expectations”. He added that further tightening now, would reduce the total size of the interest rate hikes ultimately required to “remove inflation persistence”.
