BoE disappoints investors as it lags other central banks
Cautious approach may raise the risk of higher inflation in coming years as economy struggles to keep up with demand.
The Bank of England (BoE) has raised its main policy interest rate by 0.50 percentage points (ppts) to 2.25%. Although this met the consensus expectations among economists, it disappointed investors where money markets had priced a larger rate rise.
Major central banks in developed markets have generally become more hawkish over the summer, raising interest rates by more, and signalling a longer period of tighter monetary conditions.
This was evident with the US Federal Reserve’s 0.75 ppts increase yesterday (see Fed ready to bring the pain in inflation fight) and a similar move from European Central Bank last month (see ECB turns hawkish and delivers its largest ever interest rate rise).
Despite this, the BoE’s Monetary Policy Committee (MPC) is clearly split on how fast interest rates should rise, and where they should settle at. Three of the nine committee members voted for a larger increase of 0.75 ppts, while one member preferred a smaller rise of just 0.25 ppts.
Since the MPC last met there have been two developments that materially alter the macro-economic outlook for the BoE. Firstly, the government has confirmed it will cap energy prices at a lower level for households and firms (for a limited time). Secondly, we’ve had news of a “Growth Plan” to be unveiled in the mini-Budget expected tomorrow (23 September).
While the cap on energy prices is helpful in lowering inflation in the near-term, it also supports demand in the economy which is currently deemed to be too high relative to supply. Further fiscal support is expected in the Growth Plan, which is likely to also raise demand further.
This could warrant even larger rate rises from the BoE, but the committee has decided to hold judgement until the November MPC meeting, when it will have more information with the latest quarterly Monetary Policy Report.
Today’s announcement did little to support the pound which has been under pressure in recent weeks. Sterling immediately fell by 0.8% against the US dollar, and by 0.5% against the euro.
Looking ahead, the BoE is likely to continue raising rates at a brisk pace. Whether or not it decides to accelerate the pace in November is yet to be seen. Money markets before the meeting had priced the peak in UK rates at 4.5% by the second quarter of 2023.
For the moment, the BoE does not seem to be ready to raise interest rates that high. This raises the risk of higher inflation in coming years as the supply side of the economy struggles to keep up with demand.
The views and opinions contained herein are those of Schroders’ investment teams and/or Economics Group, and do not necessarily represent Schroder Investment Management North America Inc.’s house views. These views are subject to change. This information is intended to be for information purposes only and it is not intended as promotional material in any respect.