As expected, the Bank of England (BoE) has raised its policy interest rate by 0.25% to 4.5% - the 12th consecutive interest rate rise, as persistent inflation has continued to surprise the rate setting committee at the central bank. Headline Consumer Price Index (CPI) inflation remained above 10% in March, substantially higher than in mainland Europe or the US.
Alongside its latest decision was the publication of the Monetary Policy Report (MPR), presenting the BoE’s current assessment of the inflation outlook and the prospects for the economy. The highlight and possibly even a concern for investors are the upward revisions to the BoE’s growth and inflation forecasts, both of which could potentially mean interest rates may need to be higher for longer.
The BoE’s GDP forecast one-year ahead (Q2 2024) has been revised up from -0.3% to +0.9% - the biggest such upward revision in the history of the independent central bank. CPI inflation for the same period was revised up from 1% to 3.4% - not the largest, but certainly a considerable upwards revision.
Food inflation was cited as one of the main causes of the upside surprise to inflation. Manufacturing and supply costs have turned out to be higher than expected when compared to wholesale prices. The role of the energy price caps may have lowered inflation over the winter, but it is also slowing the fall in household energy costs now, as we have seen in Europe.
The BoE is also concerned over domestic inflation pressures, excluding food and energy. The labour market has started to weaken in response to the rise in interest rates, but short of waning demand, the unemployment rate has not yet risen much, and certainly not enough to ease the concerns over wage pressures.
One change for this interest rate cycle which the BoE highlighted as an important factor is the high proportion of households on fixed-rate mortgages. This has reduced the impact of rising interest rates on the household sector compared to the equivalent level of interest rates seen historically. We have been highlighting this phenomenon for some time and it is the reason why we had a stronger growth forecast and higher inflation forecast than the BoE. Indeed, this information was known and reported by the BoE over a year ago, and yet, it is only now receiving attention from policymakers.
The BoE’s forecast still has inflation falling sharply in coming months, and falling within the central target range (1-3%) by the third quarter of 2024, and below 2% by the first quarter of 2025. This is a signal to investors that not enough interest rate cuts are priced in over the medium term. Yet, markets have been ignoring the BoE’s guidance of late, unsurprisingly given its poor forecasts.
Looking ahead, the BoE is no longer offering much in the way of forward guidance. It is responding to data, and recent rate rises have been a response to the rising probability of even higher inflation over the medium term. In other words, the BoE thinks it has done more than enough to see inflation return to its target, but has continued to raise interest rates as the chance that it is wrong has risen.
We think the BoE is close to ending its interest rate hikes, but we may have one more rate rise next month. Inflation and labour market data in coming weeks will be important determinants. If hiring remains firm, wages continue to accelerate and there is a smaller fall in inflation than expected, then the Bank may need to tighten further.