Bank of England holds rates after inflation shock

In a finely balanced decision, the Bank of England’s monetary policy committee today voted to leave interest rates unchanged at 5.25 per cent. The move brings an end to a run of fourteen consecutive interest rate hikes, and represents the first time in almost two years that the Bank has elected not to raise rates.

At the start of this week, a further interest rate increase was seen as a safe bet by traders and analysts, but Wednesday’s positive inflation figures complicated the monetary policy committee’s decision. Following the release, market pricing rapidly adjusted, implying that investors saw an even chance of a 0.25 percentage point hike on Thursday. In the end, 4 members voted for a 0.25 point hike, while 5 members (including governor Andrew Bailey) voted to leave interest rates unchanged.

Economists were pleasantly surprised by inflation figures showing that the headline rate of UK inflation decelerated from 6.8 per cent in July to 6.7 per cent in August. Forecasters had expected a temporary uptick in the annual rate of CPI, driven by base effects and higher fuel prices. In a sign that persistent inflationary pressures are easing, the core inflation rate dropped from 6.9 per cent to 6.2 per cent, while services inflation also fell significantly from 7.4 per cent to 6.8 per cent. 

But despite positive inflation news, the wider economic picture is mixed. UK wage growth remains high, with average earnings outpacing inflation again last month. GDP shrank by 0.5 per cent in July, prompting fears that ‘overtightening’ by the central bank could see the UK economy stall. 

In a statement released alongside the decision, policymakers said that “there are increasing signs of some impact of tighter monetary policy on the labour market and on momentum in the real economy more generally”. It added that given the scale of rate hikes so far, policymakers judge current interest rates to be “restrictive”.

Following the announcement, Yael Selfin, Chief Economist at KPMG UK said that UK interest had now “potentially reached their peak in this cycle”, though not all economists are convinced. Hugh Gimber, global market strategist at J.P. Morgan Asset Management said that further tightening could prove necessary, adding that “the risk of today’s decision is that the Bank may yet be forced to apply the brakes more sharply at a later stage.”

In any case, rate-setters signalled that rate cuts could be some time away. The monetary policy statement said that “monetary policy will need to be sufficiently restrictive for sufficiently long to return inflation to the 2 per cent target sustainably in the medium term”. The committee also voted unanimously to accelerate the pace of quantitative tightening, with bond sales increasing from £80bn to £100bn over the next twelve months. 

This comes after the US Federal Reserve held its base rate last night, amid worries of over-tightening, and the European Central Bank increased its rate last week.