London: The Bank of England raised its benchmark lending rate to the highest level since 2008, saying further increases may be needed if inflationary pressures persist.
The UK central bank lifted its key rate a quarter point as expected to 4.5 per cent, with two of the nine-member Monetary Policy Committee voting for no change. The majority of the panel said “repeated surprises” pointing to the resilience of the economy have added to price pressures and required action.
Officials led by Governor Andrew Bailey also delivered the biggest upgrade to growth projections since the BOE gained independence in 1997, erasing a recession previously forecast and anticipating the real economy will be 2.25 per cent bigger by mid-2026 than it thought in February.
The pound trimmed losses and gilts pared gains after decision. Money market traders added to wagers on BOE tightening, pricing in almost 50 basis points further tightening this cycle, which would take the key rate just below 5 per cent by September.
By the end of 2023, inflation is forecast to have fallen to 5.1 per cent. While above the 3.9 per cent previously forecast, it would be enough for Prime Minister Rishi Sunak to meet his pledge to cut inflation in half this year. Higher mortgage costs are also bumping up rental prices, as landlords demand higher sums from tenants and some look to sell their properties due to rising expenses.
The Labour party lashed out at Sunak on Wednesday, blaming him for higher mortgage costs due to his perceived failure to boost growth in the economy post-pandemic. The cost-of-living crisis is expected to become major issues in the general election widely expected next year.
“The MPC has again been driven to raise rates by stubbornly high inflation, ongoing strength in wage growth, and better-than-expected activity,” said Anna Leach, deputy chief economist for Confederation of British Industry. With inflation having been at or above 9 per cent for a full year, the Bank are rightly concerned that higher inflation could become entrenched” .
The latest rate decision continues the quickest round of increases in four decades, a move the BOE expects to weigh more heavily on households and businesses in the coming months. The BOE is fighting double-digit price increases that remain stronger than the forces buffeting the US and Eurozone.
“If there were to be evidence of more persistent price pressures, then further tightening in monetary policy would be required,” the BOE said Thursday in minutes of the decision. That language was unchanged from March’s meeting, which at the time was interpreted as opening the door to a pause in the hiking cycle.
Since then, inflation, economic growth and surveys about the labor market all surprised on the upside. That prompted investors to price in more rate hikes through the summer to as much as 5 per cent even as the US Federal Reserve signaled the possibility of a pause.
The BOE raised both its growth and inflation forecasts, and it also estimated a smaller increase in unemployment than it had anticipated in February when it last updated its outlook. Officials expect Chancellor of the Exchequer Jeremy Hunt’s budget measures outlined on March 15 to add 0.5 per cent to gross domestic product, above the 0.3 per cent assumed in February.
The improvement was mainly due to lower energy prices, along with fiscal stimulus and lower unemployment boosting consumer confidence and spending.
Officials also were optimistic that the UK would be spared the worst of the banking crisis hitting the US, where authorities arranged a hasty buyout for First Republic Bancorp and rescue for Silicon Valley Bank. The tremors in the banking sector are expected to shave 0.25 per cent of US growth, according to the BOE’s forecasts.
While the BOE was forced to intervene on with the UK unit of SVB, that didn’t appear to influence Thursday’s rate decision.
“The impact of recent global banking sector developments on domestic credit conditions and hence UK GDP was expected to be small,” minutes of the decision said.
But higher food price inflation are offsetting some of the optimism, the BOE noted, as it emphasized the unprecedented nature of trade shock from the war in Ukraine and said it was unsure how long it would take for improvements in trade to feed through into lower prices.
Price, wage strength
Silvana Tenreyro and Swati Dhingra for a third meeting voted in the minority for no change in rates. They anticipate a sharp drop in inflation this year will alleviate the persistent elements of price pressures and were concerned that “sizable impacts from past rate increases were still to come through.” They said increasingly “restrictive” policy may bring forward the point at which rates must be cut.
Bank staff estimated that only about a third of the effect of the rate hikes, which have taken the base rate from 0.1 per cent in December 2021 to 4.5 per cent, has fed through to consumers.
The majority of the panel including Bailey and two deputy governors said “it was important to continue to address persistent strength in domestic price and wage setting” after inflation and GDP both turned stronger than expected.
Unemployment is now projected to be flat at 3.8 per cent in the second quarter, lower than February’s prediction of 4.1 per cent. While there were signs that the labor market was loosening, it remains tighter than it was three months ago, though BOE agents reported fewer difficulties in finding staff.
The BOE now expects inflation to dip to a little above 1 per cent - well below the 2 per cent target - at the forecast horizons in both two and three years. That assumes rates rise in line with current market betting.
The decision leaves the BOE and European Central Bank leading the global fight against inflation. ECB President Christine Lagarde last week was keen to emphasize that the eurozone was not yet done with rate hikes, but the ECB’s main deposit rate at 3.25 per cent is still well below the BOE’s.
The BOE’s unprecedented string of 12 consecutive rate hikes has pushed mortgage costs higher, and millions of homeowners will feel the pain as they draw to the end of their fixed-term deals.
The bank estimates 1.3 million households will come to the end of their fixed-term mortgages this year. By December 2025, changes in mortgage interest payments are expected to eat into consumption by 0.55 per cent, the BOE said.