The Bank of England has raised interest rates by 50 basis pointsthis is the biggest increase in the cost of money since 1995. The BoE also announced that the UK will face the longest recession since the global financial crisis.
This is the sixth consecutive increase that has brought the reference rates from 1.25% to1,75%. Recall that it is the first increase of half a percentage point since the Bank was made independent by the British government in 1997.
The Monetary Policy Committee voted with a majority of 8-1 in favor to raise rates by half a point, citing rising inflationary pressures in the UK and the rest of Europe compared to the previous May meeting.
“This largely reflects an almost doubling of wholesale gas prices since May, due to Russia’s restriction of gas supplies to Europe and the risk of further cuts,” states the Monetary Policy Committee in the press release.
The Bank now expects headline inflation to peak at 13,3% in October and remains at high levels for much of 2023, before falling towards its target of 2% in 2025. Markets had largely priced the more aggressive rate approach at the August meeting, as UK inflation hit a new high in June in June. 40 years of 9,4% a while the prices of food and energy continued to rise, exacerbating the country’s historical cost of living crisis.
Bank of England Governor Andrew Bailey promised last month that there would be no “ifs” and “buts” in the central bank’s pledge to push inflation back towards the 2% target.
BoE starts selling unexpired government bonds
The central bank outlined plans to sell some of the bonds acquired during the QE (Quantitative Easing) programs that began in the wake of the global financial crisis due to the pandemic. The BoE began reducing the amount of government bonds it still holds in March. So far it has done so by letting the acquired bonds mature without buying new ones to replace them, an approach similar to that of the Fed. Today, however, he proposed a plan to start selling government bonds that have not yet matured as early as September. Together with the maturing bonds, a total of 80 billion of pounds in a year. MPC members will vote on the proposal at their September meeting.
Furthermore, the BoE has stated that it intends to start sales of government bonds even before maturity for a value of approximately 10 billion pounds quarterly starting from September, subject to the final green light from policy makers (the UK government).
Recession in sight for five quarters
The Bank showed the UK’s economic growth prospects disastrous suggesting that the latest gas price hike led to another “significant deterioration” in the outlook for business in the UK and the rest of Europe.
According to estimates by the Monetary Policy Committee, the UK will enter a recession from the fourth quarter of 2022 e the recession will last five quarters as real after-tax household income will decline dramatically in 2022 and 2023 and consumption will begin to contract.
Negative prospects in the medium term also with regard to the labor market, according to the forecasts of the BoE economists, the unemployment rate by 2025 will increase to 6.3% compared to the current 3.8%.
The economic forecasts offer a grim reading – a significant decline in GDP that will extend into 2024 – although it is not possible to ignore the fiscal easing that a new Prime Minister could implement in the fall. Further rate hikes are likely as inflation will remain uncomfortably high in the coming months “, writes in a note Hetal Mehta, Senior European Economist di Legal & General Investment Management
The reaction of the market and analysts
According to most analysts, the historical rise of half a percentage point was widely expected and priced by the markets, what surprised are the outlook on inflation and economic growth. The pound marks a decrease of 0.30% against the dollar to 1.2107, the Ftse 100 remains just above par (+ 0.08%) just before the end of the session while the yield of the 10-year gilt currently falls to 1 , 85%.
The 50 basis point rate hike was expected by the market with Bank of England Governor Andrew Bailey making it clear last month that such a move was ‘on the table’. However, the outlook painted today is extremely negative, with a recession expected to start in the fourth quarter of this year. While an expected inflation spike of over 13% in the near term suggests that more hikes will be needed, it is clear that the impact this will have on the real economy is being realized, with a particularly surprising forecast for unemployment jumping to 6. 3% by 2025. As a result, we maintain our view that, in the end, the Bank of England will be less aggressive than the Fed in raising rates, given the relative growth prospects, writes Jamie Niven, Senior Fund Manager at Candriam
“The Bank of England has accelerated the pace of tightening as it faces the ongoing trade-off between rising inflation and worsening growth prospects, confirming that tackling high prices is the priority in the short term. Hetal Mehta di Legal & General Investment Management. “The economic forecasts offer a grim reading – a significant decline in GDP that will extend into 2024 – even if it is not possible to ignore the fiscal easing that a new Prime Minister could implement in the fall. Further rate hikes are likely as inflation will remain uncomfortably high in the coming months “, goes on.