Bank of England expected to raise interest rates to 5.5%

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Financial markets and economists expect the Bank of England to raise interest rates by 25 basis points at Thursday’s meeting, pushing borrowing costs to 5.5%, the highest level since early 2008.

While Bank of England rate setters have made comments over the past month aimed at giving them the option of keeping rates at 5.25%, the European Central Bank made a similar move last week.

The near certainty among economists and financial markets reflects the Bank of England’s guidance that they will raise interest rates again if there are further signs of persistent inflation, already visible in the latest wage and service cost data.

This evidence contradicts signals from Threadneedle Street in recent weeks. Many members of the central bank’s monetary policy committee sought to cast some doubt on the September decision, given that borrowing costs are high enough to curb economic growth and inflation.

Huw Pill, chief economist at the Bank of England, said that if the Bank of England raises interest rates further and then has to cut interest rates as financial markets expect, or if the Bank of England pauses interest rate increases and keeps interest rates at current levels for a long time, inflation will fall. He said he was “leaning” toward the latter.

Bank of England governor Andrew Bailey and deputy governor Sir Jon Cunliffe gave evidence to MPs this month and agreed that interest rates were “close to the top of the cycle”.

Swati Dhingra, the fourth member of the Monetary Policy Committee, said she believed rates had risen too much and there was a serious risk of overtightening.

While four of the nine MPC members said they were unsure whether further rate hikes were needed, economists said data from the rate-setters’ meeting in early August said inflation was too high for the BoE to pause immediately.

In the year to July, private sector wages grew by 8.1% and services industry inflation was 7.4%, both well above the Bank of England’s August forecast.

But the 15th rate hike this cycle is likely to be the last. Paul Hollingsworth, chief European economist at BNP Paribas, said he expected a “modest rise” in interest rates to 5.5%, while a majority of the committee now believes rates may not need to rise further rate hike.

Capital Economics said a quarter-percentage point hike “will be the last of this cycle”, while Deutsche Bank said “the door is open” for a pause after the Bank of England raised interest rates to 5.5% on Thursday.

Financial markets have taken the same stance. At the end of last week, they still expected rates to rise by a quarter of a percentage point on Thursday, which they considered the current peak. In contrast, after the Monetary Policy Committee’s August meeting, the market still expected interest rates to reach 5.75% this year.

Krishna Guha, vice chairman of Evercore ISI, said that despite a concerted effort to convince everyone that further rate hikes are not needed, the data has not yet justified a pause in rate hikes.

The big unknown for economists both inside and outside the Bank of England is August inflation data, due early on Wednesday, a day before the interest rate decision is announced.

Price growth in July was 6.8% and is expected to rise to around 7.1% due to higher petrol and diesel prices last month and an increase in alcohol taxes.

The modest rise in inflation is unlikely to attract policymakers’ attention, as it was the central bank’s August forecast, but the MPC will be paying particularly close attention to trends in services data.

The central bank views growth in domestic service prices, especially in areas such as restaurants and hotels, as a strong indicator of potential inflationary pressures. Inflation in this area has been rising steadily and only August data improve significantly before the MPC votes to pause inflation.

Economists said other major developments in economic data over the past month were likely to be overshadowed by the MPC. They said the revised results, which showed the UK economy would perform nearly 2% better in 2020 and 2021 than previously expected, were unlikely to change the MPC’s view on inflationary pressures.

Andrew Goodwin, chief U.K. economist at Oxford Economics, said the upgrade was more likely to change policymakers’ view of how fast the economy is growing without generating more inflation than to make them see price pressures this year. bigger. “It is unclear whether these revisions will affect the Monetary Policy Committee’s interest rate stance,” he said.

In addition to the interest rate decision, the MPC must also decide how much gilts the Bank of England will sell next year as part of its quantitative tightening process.

This is a one-off annual event at the September meeting that allows the government bond market to determine the supply of gilts. The bank’s balance sheet fell by 80 billion pounds in the past 12 months, including 34 billion pounds of sales and 46 billion pounds of maturing government bonds.

Sir Dave Lumsden, the Bank of England’s deputy governor for markets, said he expected quantitative tightening to exceed £80 billion over the next 12 months. He has previously said the sale of 34 billion pounds of gilts in 2022-23 will have no material impact on borrowing costs because the amount is small compared with the government’s total financing needs of 252 billion pounds this year.