- Bank of England raises interest rates by 0.5 percentage points
- Markets expect peak interest rates of close to 6 per cent
The Bank of England’s monetary policy committee has shocked markets and increased interest rates by 0.5 percentage points. The move marked the central bank’s thirteenth consecutive hike and takes the UK Bank Rate to 5 per cent.
The move surprised traders who had only priced in a 0.25 percentage point hike. Disappointing inflation data on Wednesday had raised last minute speculation it would be more aggressive but markets still only attached a small probability. Annual inflation remained stuck at 8.7 per cent in May, while core inflation rose from 6.8 to 7.1 per cent, the highest since 1992.
The outlook has changed significantly since the Bank’s last rate-setting meeting in May, when economists thought that the end of the tightening cycle could be in sight. The BoE had said it would only hike further “if there were to be evidence of more persistent [inflationary] pressures”. Inflation and wage growth figures released since then have provided a pretty indisputable case.
Capital Economics, one forecaster that predicted the half point hike, said: "A lot of attention has focussed on the fact that inflation failed to fall in line with expectations last month and was instead unchanged at 8.7 per cent. But the bigger concern in our view is that core inflation rose yet again, hitting a 31-year high of 7.1 per cent.
"Accordingly, a failure to deliver could cause financial conditions to loosen and the pound to weaken, which is the last thing that policymakers at the Bank need right now."
The Monetary Policy Committee vote was split. It voted by a majority of 7–2 to increase the Bank Rate by 0.5 percentage points, to 5 per cent. Two members preferred to maintain Bank Rate at 4.5 per cent. No one voted to only raise rates by 0.25 points.
Following the decision, the pound edged up against the dollar, gaining 0.3 per cent on the day at $1.2810. Yields on the interest-rate sensitive two-year gilts moved slightly, dropping to 5.01 per cent from 5.06 per cent. Luke Bartholomew, senior economist at abrdn, said: "While some investors had been speculating about the risk of a 0.5 point increase today, this decision will come as a shock for many in the market."
What next for interest rates?
Markets expect interest rates to peak as high as 6 per cent this year, although economists are torn on whether or not they would reach that level.
Chief Economist at KPMG UK Yael Selfin said big interest rate increase were probably not the final word from the Bank of England. She said: “If inflation continues to prove stubbornly high, we should expect interest rates to not only rise further but also to remain higher for longer before the cost-price developments come decisively under control.”
Analysts at Berenberg revised their forecasts for interest rates upwards in light of Wednesday's inflation release. They now expect the bank rate to rise to 5.25 per cent by the end of the year, up from a previous projection of 5 per cent.
However, analysts at Pantheon Economics were more optimistic and noted that producer price inflation (which gives an indication of pipeline pressures) had fallen sharply and wage growth would also slow.
Has the bank gone too far?
Despite Wednesday's figures, economists still expect inflation to fall rapidly over the next few months as energy price ‘base effects’ kick in and food prices stabilise. The long time lags associated with monetary policy also mean that the full impact of previous rate hikes have yet to be felt. As a result, economists have warned against the BoE tightening too far.
Berenberg chief economist, Holger Schmeiding, said that though fixed-rate mortgages lengthen the time taken for higher rates to hit the economy, the pass-through “will still happen”. Data released by the Institute for Fiscal Studies think tank yesterday showed that the rate on an average two-year fixed mortgage now stands at 6.01 per cent, up from 2.65 per cent in March 2022. The think tank estimates that average mortgage-holding households will pay almost £280 more each month as a result.
According to Schmeiding, there is a risk that the BoE has overreacted to short-term inflation surprises, and and increased interest rates too far. He added that this over-tightening could even risk “an inflation undershoot once the full effects of its prior policy decisions play out”.
