UK central bank ups rates to 2.25%, sells £80bn gilts

The UK’s central bank raised its key interest rate to 2.25% from 1.75% on Thursday and said it will continue to “respond forcefully, as necessary” to control inflation.

The Bank of England’s Monetary Policy Committee (MPC) voted 5-4 to increase the Bank Rate by 0.5 percentage points. Deputy Governor Dave Ramsden and external MPC members Jonathan Haskel and Catherine Mann voted for an increase to 2.5%, while new MPC member Swati Dhingra wanted a smaller rise to 2%.

The MPC also voted unanimously to reduce the central bank’s stock of purchased UK government bonds, financed by the issuance of central bank reserves, by £80 billion over the next 12 months, to a total of £758 billion, in line with the strategy set out in the minutes of the August MPC meeting.

“The scale, pace and timing of any further changes in Bank Rate will reflect the Committee’s assessment of the economic outlook and inflationary pressures,” said the MPC.

“Should the outlook suggest more persistent inflationary pressures, including from stronger demand, the Committee will respond forcefully, as necessary.

“At its August meeting, the MPC had communicated that it was provisionally minded to commence gilt sales shortly after its September meeting, subject to economic and market conditions being appropriate.

“At this meeting, the Committee agreed that the conditions were appropriate, and voted to begin the sale of UK government bonds held in the Asset Purchase Facility shortly after this meeting.”

REACTION:

Luke Bartholomew, senior economist, Abrdn: “Not long ago, a 0.5 percentage point interest rate increase in one meeting would have been seen as a very large and rapid increase in borrowing costs.

“However, given the much larger rate increases we have seen from a number of central banks across the world, a 50bps increase actually looks rather small today.

“The Bank of England therefore continues to look like something of a laggard compare to international peers, which is likely to keep the pound under selling pressure.

“Market attention will now move to the fiscal announcement from the government tomorrow, which looks set to deliver a significant easing in fiscal policy.

“Given the degree of underlying inflation pressure in the economy, this fiscal easing will almost certainly be met by a series of further interest rate hikes from the BoE.”

Ian Stewart, chief economist at Deloitte: “Hiking rates when the economy is heading into recession and inflation close to a peak testifies to the Bank’s concern that inflation has become embedded in the system.

“The Bank is unlikely to stop raising rates until price pressures and labour shortages have eased significantly.

“We expect rates to double by the middle of next year, causing a significant tightening of credit conditions, and adding to the downward momentum in the economy.”

Victoria Scholar, Head of Investment, Interactive Investor: “The Bank of England raised interest rates by 50 basis points to 2.25%, its seventh consecutive rate hike.

“However the increase was less hawkish than many analysts were expecting with the market pricing in a more aggressive 75 basis point increase ahead of the announcement.

“The bank rate is now at the highest level since 2008 as the Bank of England attempts to curtail spiralling price rises with inflation just shy of double digits, sharply above its 2% target.

“The vote was by no means unanimous. There was a 5-4 split in favour of a 50-basis point increase. Three members voted to raise rates by a more aggressive 75 basis points while one member voted for a more moderate 25 basis point hike.

“The central bank downgraded its forecast for peak inflation, projecting price levels to reach just under 11% in October below its previous forecast for 13.3%.

“It said CPI is expected to remain above 10% for a few months after October before falling.

“The Bank of England said third quarter GDP is expected to hit -0.1% quarter-on-quarter, meeting the technical definition of a recession, namely two consecutive quarters of negative growth.

“Governor Andrew Bailey said the UK’s energy price guarantee will significantly limit further inflation rises but adds to inflation pressure in the medium term.

“The pound initially pared gains after the announcement against the dollar and traded flat against the euro while 2 and 5-year gilt yields rose to the highest level since 2008.

“Today’s announcement suggests the Bank of England is concerned about the UK’s economic deteriorating outlook amid the looming threat of recession.

“The central bank’s decision was more dovish than markets expected, particularly following the Fed’s hawkish 75-basis point rise yesterday and the recent depreciation for the pound.

“The timid increase will do little to stem the slide in sterling but may avoid inadvertently inducing unnecessary pain for the economy which is already grappling with slowing demand and deteriorating confidence.”

Kevin Brown, savings specialist at Scottish Friendly: “With little surprise, the Bank of England has hiked interest rates again. It’s the biggest rise for 33 years, which means there are a few essential implications for households to be aware of.

“Rising interest rates will likely have a swift impact on debts – in particular any debt that isn’t on a fixed rate. This includes things like credit cards and some (but not all) loans. Anyone with this kind of debt should look to find a way to fix their interest payments as quickly as possible to avoid higher payments biting.

“Better yet, paying down as much debt as possible, wherever possible could be a good habit to get into. Beyond paying off debts, trying to put money away for a rainy day is a good way to build a buffer, especially with so many unexpected bills likely in the current climate.

“Ultimately though, even the best rates are still way behind high levels of inflation. For long-term wealth, investing could still be a feasible route to growth.”

Daniel Mahoney, UK Economist at Handelsbanken: “As we predicted, the Bank of England has today for the second time since independence increased interest rates by 50bp, taking bank rate up to 2.25%. MPC members were split on the decision: three members backed a 75bp increase; five voted for 50bp; one backed a 25bp increase.

“The Committee did, however, unanimously agree to quantitative tightening (QT) of £80bn over the next twelve months, which will include passive QT (not re-investing the proceeds of maturing assets) and active QT of around £10bn of sales per Quarter.

“Recent data on the UK economy along with poor retail sales will likely have persuaded a number of MPC members to opt for a 50bp rather than a 75bp increase. Moreover, the announced energy price cap that has dramatically lowered the projected peak of inflation and improved the short-term economic outlook could also mean that the Bank feels less pressure to front-load rate increases …

“That said, markets are still expecting rapid increases in interest rates: expectations are currently that rates will land at near to 5% by mid-2023. And there are, indeed, numerous factors that mean further monetary policy tightening should be expected.

“Latest employment data highlights a UK labour market that remains very tight, which could feed pressures on wages. And, of course, other central banks are continuing to implement considerable rate increases, the most recent of which was the Federal Reserve’s 75bp increase yesterday.

“The US’s core rate of inflation saw an unexpected jump in August, which points to the fact that the Fed’s tightening cycle is far from over. MPC members will be mindful of the impact this could have on Sterling that has already seen major falls in recent weeks: the Pound is roughly 7% down against the Dollar since early August and the Pound’s effective exchange rate is down by roughly 4% over the same time period.

“The Bank will worry about the inflationary impact of a sustained weak Pound given the UK’s high import-dependence …

“We agree that these factors point to further hikes in interest rates, and announcements at tomorrow’s fiscal event may add pressure on the MPC to act.

“However, we do not expect increases to the extent that markets are currently pricing in. The economy is not currently showing signs of overheating.

“And, of course, one of the key unknowns here is the impact of QT. The Bank has now signed off on active sales of gilts, which will speed up QT and act as a deflationary force over the coming years.”

Walid Koudmani, chief market analyst at financial brokerage XTB: “As widely expected, the Bank of England increased interest rates to 2.25% following other major central banks in an attempt to contain inflation while economic projections continue to be negative for the last part of the year.

“Despite some short term volatility, the FTSE100 continues to hover in the 7220 points area while the pound is attempting to secure some gains after pulling back slightly in the immediate reaction as some investors had hoped for a more aggressive hike.

“This rate hike will however do little to dissuade those investors who remain disappointed with the slow reaction of the UK’s central bank to help curtail runaway inflation. Last night the US Federal Reserve yet again delivered an aggressive 75 basis point hike. Put that against the BoE’s actions and it’s easy to understand the broader market disappointment.”

Ben Laidler, Global Markets Strategist at social investment network, eToro: “Today’s contentious move from the Bank of England makes it a global outlier amongst other central banks. With only three of nine policymakers voting for a sharper hike, the Bank bucked the consensus and hiked interest rates just 0.5%, with its seventh consecutive rise taking interest rates to 2.25%.

“The slow and steady approach partly reflects the government’s dramatic £200 billion new spending plans. These reduce near term inflation and recession risks, but at a longer-term inflationary cost. It will also be at a continued cost to Sterling, already down 17% versus the dollar this year, and bond prices, with 10-year gilts 19% weaker since the start of the year.

“Long-suffering savers will welcome the higher interest rates, but they also pile further pressure on mortgage payers, with this rise alone adding £700 to the annual cost of the average UK mortgage.”

Tony Syme, finance and economy expert, University of Salford: “Another month, another interest rate rise, but now with a quickening pace.

“And the Bank of England is not alone in this. Yesterday, the US Federal Reserve announced that it was raising its key rate by three-quarters of a percentage point and that only mirrors the same rise announced by the European Central Bank earlier this month.

“The big question is how far will interest rates rise. There are two things to consider. The first is that interest rates are almost always above the rate of inflation. Apart from the years of very high inflation in the 1970s, the Bank of England’s Bank Rate has always been above the inflation rate for the last 70 years.

“If inflation is greater than the rate of interest, any returns from lending money are more than wiped out by the fall in the value of money, so there is no incentive to lend. A positive ‘real interest rate’ is needed to ensure the market’s supply of loanable funds.

“A higher interest rate also enables monetary policy to be ‘active’. When the Bank Rate was lowered to 0.5% in March 2005, the Bank of England faced the ‘zero lower bound’ problem.

“Interest rates could hardly be lowered any further, so it had to turn to more unconventional monetary policy measures such as quantitative easing. The Bank of England didn’t change interest rates again until August 2016.

“The second thing to consider is the relationship between the Bank of England and the Federal Reserve, or at least between their two currencies. With the dollar as the key international currency, it has been viewed as the most stable currency in the world economy.

“The risk premium is near zero and lower than for other currencies. To offset that risk premium when buying financial assets in sterling, investors need a higher return of their investments in sterling and so interest rates are generally higher in the UK than in the US. That risk premium will only increase with the large increase in government borrowing to be announced in tomorrow’s mini-budget.

“Since the start of the 1990s, the rate set by the Bank of England has always been higher than the rate set by the Federal Reserve which two short exceptions: May-December 2000 and March-December 2006. At their peak, interest rates were 0.75 percentage points higher in the UK than in the US, while in the other periods, interest rates were up to 7 percentage points higher in the UK than in the US.

“All this pre-dates the Financial Crisis of 2008-09 and this was the era of stable, conventional monetary policy to which both central banks would like to return. In this period, the Bank of England generally set its interest rate two percentage points higher than expected inflation rate and around one percentage point higher than the Federal Reserve.

“With an inflation target of two percent, this suggests that we should expect to see interest rates rise to at least 4 percent and not be lowered again. If government borrowing continues to rise, that interest rate will rise even further due to the increased risk premium and if the Federal Reserve continues to raise interest rates, then we should expect the same in the UK.

“One thing is clear. The era of cheap interest rates and unconventional monetary policy is over. We can expect interest rates to be in the 4-5 percent range even in good economic times.”

 

About the Author

Mark McSherry
Dalriada Media LLC sites are edited by veteran news journalist Mark McSherry, a former staff editor and reporter with Reuters, Bloomberg and major newspapers including the South China Morning Post, London's Sunday Times and The Scotsman. McSherry's journalism has also appeared in The Washington Post, The Guardian, The Independent, The New York Times, London's Evening Standard and Forbes. McSherry is also a professor of journalism and communication arts in universities and colleges in New York City. Scottish-born McSherry has an MBA from the University of Edinburgh and a Certificate in Global Affairs from New York University.