The UK central bank, the Bank of England, raised its key interest rate to 3.5% from 3% on Thursday, its ninth rate rise in a row.
The BoE’s Monetary Policy Committee voted 6-3 in favour of the move, and said “further increases in Bank Rate” may be required to tackle what it fears may be persistent domestic inflation pressures from prices and wages.
“The labour market remains tight and there has been evidence of inflationary pressures in domestic prices and wages that could indicate greater persistence and thus justifies a further forceful monetary policy response,” the central bank said.
The UK central bank’s move follows the US Federal Reserve’s decision on Wednesday to raise its main rate by half a point.
The European Central Bank is set to raise interest rates for the fourth time in a row on Thursday.
Neil Shah, Executive Director at investment research firm Edison Group: “The BoE’s interest rate hike of 50 basis points follows the Fed’s pivot last night and signals a slowing in rate increases on a global scale. The MPC’s 6-3 vote, with two members voting for unchanged rates also suggests a near consensus on more careful tightening.
“Inflation remains rampant at 5 times the target of 2%, yet a number of indicators point to a downward trend next year.
“As both CPI and core inflation have stabilised since the October high, the UK labour market shows one of the most cautiously positive trends yet – a gradual return to the workforce by those who dropped out post-pandemic. While the BoE has warned of the dangers of wage inflation, unemployment is creeping up slowly as the labour market begins to loosen, which is a positive sign for coming months.
“The question for next year remains where interest rates will plateau and how deep and long a recession will hit the economy. If the labour market does indeed show signs of loosening, the BoE may well want to stand back and watch how embedded inflation remains in the economy.
“UK Markets will be gearing up for a Santa rally, which has seen the FTSE gain on 86% of occasions since 1985. It is hoped this positive momentum will be maintained into early next year, when December retail figures will signal how hard consumer inflation has impacted the shopping season.”
Daniel Mahoney, UK Economist at Handelsbanken: “This was expected and had been priced as the most likely outcome by markets. There was a small probability of the BoE going further with a 75bps hike, but data released this week showing a marginal easing in the labour market and inflation coming in lower than expected will no doubt have tilted the balance of opinion on the MPC towards a 50bps hike.
“However, there were, of course, significant differences of view among MPC members. One member of the committee voted for a larger 75bps increase on the basis that price and wage pressures could stay stronger for longer than projected in the BoE’s November report; on the flip side, two members voted for no change to interest rates, arguing that current bank rate was more than sufficient to bring inflation back to target in the medium term …
“Central banks across the Western world now appear to be approaching the peak of interest rates in this tightening cycle. Yesterday, the US Federal Reserve increased rates by 50bps, down from its previous four hikes each of 75bps; the BoE today followed suit.
“The two key questions for UK monetary policy now are where will interest rates peak and how long will they remain at the peak? In the UK’s case, the MPC will need to weigh up various competing priorities. The BoE confirms that UK is probably in recession – which will act as a natural brake on inflation – and the MPC will also be conscious of financial stability risks arising from the already started correction in the property market. All things considered, we are of the view that the BoE will increase rates further to a peak of 4%, which is below current market expectations.
“With the proviso that we do not experience a fresh geopolitical shock, it seems likely that CPI inflation’s peak was in October – and factors including energy price base effects, falling supply chain disruption and collapsing shipping costs will all work to diminish inflation in 2023.
“That said, we do not anticipate that inflation is going to be falling close to its 2% target level in the short to medium term. The iterative nature of inflation, businesses gauging how they accommodate price pressures and then adjusting their responses as they see how others act, can easily take a year or more. Services inflation, in particular, is likely to be more difficult to remove from the system due to domestically-led pressures. We therefore at this stage believe the BoE will hold rates at the peak of 4% throughout 2023 and into 2024 …
“Quantitative tightening (QT), the reduction of holdings in the Asset Purchase Program, is also a factor to take into consideration when considering the direction and scale of future monetary policy.
“Assuming the BoE proceeds with the full £40bn of active sales and continues passive QT (not buying new assets to replace ones that mature) until mid-2025, the BoE will have reduced its balance sheet by roughly a quarter from its £895 billion peak.
“A cautious estimate based on evidence from the United States suggests that this would be the equivalent of increasing interest rates by 50bps on a sustained basis. Handelsbanken UK will be publishing a paper examining the potential impact of QT early in the New Year.”
Susannah Streeter, senior investment and markets analyst, Hargreaves Lansdown: “It means the chill descending on the UK economy is set to turn into a much colder snap, with the latest hike in interest rates, freezing off growth further in a bid to cool inflation, which is still at the steaming rate of 10.7%.
“This is the ninth consecutive rate rise since December last year and the last time the rate stood above 3% was in October and early November of 2008, as the effects of the financial crisis were taking hold and the Bank was in the process of rapidly reducing rates to help the economy.
“This inflation is seen as the much bigger Grinch for the UK, threatening to wipe out incomes in an aggressive price spiral which is why the Bank is trying to squeeze out demand despite the economic pain which will be inflicted. The significant price inflation in services and wage growth in the private sector are both red flagged as risks and although the economy is weakening, with a contraction of 0.1% expected for the last quarter of the year, it’s more resilient than had been expected.
“Although supply chain snarl ups have also eased, there are fresh worries about the situation with Covid rules and infections in China and there are still concerns about output which could derail supplies again, pushing up prices. The uncertain outlook and wavering price pressures meant the vote was not unanimous, with two policymakers keen for rates to remain at 3% and one outlier calling for a more aggressive 0.75% rise to 3.75%.
“The rate rise means millions more households will be dealing with more precarious finances next year, with this latest rate rise set to cause another wobble, particularly for those paying off credit cards, on variable mortgage deals or those wanting to find a new fixed rate offer.
“The Bank has already flagged in its financial stability report that four million households are to have more expensive mortgages next year and two million will have higher payments by the end of 2025. However, there are glimmers of better news now being glimpsed by investors.
“The predicted peak in UK interest rates has fallen back now, coming in a few notches above 4.5% by August 2023. This is a reflection of faster than expected easing of inflation and the return of financial stability, with Jeremy Hunt becoming the new chancellor, after the volatility experienced in September.
“The strengthening pound also has economic advantages, including to reduce import inflation, which could lead to price pressures that are not as bad as some expect as we move through 2023.
“The pound has fallen back a little further against the dollar since the Bank of England’s announcement, and is hovering around $1.23. It had already dipped back due to expectations that higher rates in the US may linger for longer while UK rates might not go as high as previously expected as recessionary cold front moves in.’’
Daniele Antonucci, Chief Economist & Macro Strategist, Quintet Private Bank: “As expected, the Bank of England followed the Fed by downshifting to a half percentage point rate hike, bringing Bank Rate to 3.5%.
“Looking at the individual votes relative to the November meeting, it appears that there is a growing consensus for a gradual taper in policy tightening, with only one committee member in favour of a 75 bps increase, and two members in favour of keeping Bank Rate unchanged.
“We do expect another 50 bps rate hike in February, as the labour market remains exceedingly tight, despite a small uptick in the unemployment rate in the three months to October.
“Policymakers will likely want to see at least some easing in wage gains and further evidence that inflation has peaked before committing to another step down in the pace of tightening.
“Ultimately, we think that the unfolding recession will force the central bank’s hand in the first half next year, leading it to keep the policy rate steady at an elevated level throughout the remainder of 2023.”
Nicholas Hyett, Investment Analyst, Wealth Club: “The Bank has played it safe with interest rates this month, with a 0.5% interest rate rises that’s bang in line with expectations. Given the mixed picture, it’s no surprise policy makers are treading cautiously.
“While the Bank seems to think inflation has peaked, or will do this quarter, it remains at eyewatering levels by historic standards.
“In particular, domestic inflation – driven by labour shortages and higher prices in non-commodity products – remains high and is far more worrying long term than the rise in global commodity prices that have been the main driver of global inflation following the Russian invasion of Ukraine.
“On the other hand, there was much to like within the minutes. The rising value of sterling is good for our buying power as a nation – taking some of the edge off international inflation. This, together with historic price rises rolling out of the data, mean headline inflation will fall substantially next year.
“That should help ease demands for wage increases, reducing the chances current inflation becomes endemic. Further good news came in the form of easing global supply pressures. What’s more, with evidence previous rate rises are now feeding through to lower borrowing by consumers and corporates, it makes sense for the bank to temper future rate rises and see how things pan out.
“All things being equal there was more to be positive about in this update than negative. Monetary policy feels like it’s on an even keel, with more sensible fiscal policy reducing the need for drastic action. Historic rate rises are having an effect, and runaway inflation has been tamed. This may not be the end of the rate rises, but on what might be the coldest day of the year there are reasons to think a tough economic winter will be followed by a thaw in Spring.”
Andrew Megson, CEO at My Pension Expert: “As interest rates rise yet again, UK savers remain in limbo. Even with inflation easing by a fraction, many will still be uncertain as to whether their money will hold its value in the months to come. It is little wonder that 37% of Britons approaching retirement feeling uncertain about their financial future.
“When faced with such volatility, some might be tempted to seek security by purchasing an annuity. After all, a silver lining of increased interest rates is annuity rates hitting a 14-year high, offering the potential of a more generous guaranteed income.
“However, whilst an annuity might suit some, it does not guarantee absolute security. Locking oneself in with a fixed annuity rate could leave individuals vulnerable to further increases in inflation. Consumers should avoid making any knee-jerk, long-term financial decisions based on short-term economic volatility.
“There are plenty of options available to help them achieve the security they crave whilst also allowing them to achieve the best possible value for money. And seeking independent financial advice will help them to achieve this.
“Whilst tempting to react to sudden economic changes, savers must try to remain level-headed, and consult an independent financial adviser about their various options. In doing so, they will begin to regain control of their financial future, and safeguard their hard-saved money.”
Douglas Grant, Group CEO of Manx Financial Group PLC: “A rise in interest rates was expected despite fears the UK is falling into recession and has reached the highest level since October 2008.
“The hikes should continue to act as a wakeup call for SMEs to review their existing lending situation and ensure they are prepared. This week’s slowing inflation data suggested that we may have reached a peak but still represented eye watering numbers and indicate that the start to 2023 will be difficult for many SMEs.
“We believe that demand for working capital will continue to rise as businesses desperately require liquidity provisions to counteract supply chain issues, increases in wages and a worsening cost-of-living crisis. Our research revealed that over a fifth of UK SMEs that required external finance over the last two years, were unable to access it.
“What’s more, over a quarter have had to stop or pause an area of their business because of a lack of finance. SMEs continue to struggle with accessing finance and, worryingly, this lack of availability is costing them and the UK economy in terms of growth at a time when it is needed the most. The amount of growth that is being sacrificed is significant and will require new solutions which are designed to address this funding gap.
“Despite positive introductions and extensions to loan schemes in 2022, such as RLS Phase 3, more needs to be done. For some time, we have been calling for a sector focused permanent government-backed loan scheme which brings together both traditional and alternative lenders to guarantee the future of our SMEs.
“As the government looks for ways to power the economy’s resurgence in 2023, the importance of a permanent scheme cannot be understated, it could act as the fundamental difference between make or break for many companies and, in turn, our economy. We very much hope this is something that becomes a reality.”
David Bharier, Head of Research at the British Chambers of Commerce (BCC): “Today’s interest rate rise to 3.5%, while expected, adds further pressure to firms facing soaring costs from all directions.
“With some evidence of inflation now beginning to ease, it will be vital that further interest rate action does not exacerbate the recession the UK is entering.
“Today’s increase to the interest rate will come as bad news for both mortgage holders and firms that have higher borrowing costs, particularly those who need to buy in bulk to mitigate against supply chain shocks.
“The Bank of England now face a conundrum of when to ease monetary policy, given that the main drivers of inflation have shifted from external factors, such as shipping and raw material costs, to domestic factors, such as energy and labour costs.
“Only business investment and growth will solve the stagflation problem. Firms need to see concrete actions on the measures that produce the right environment to invest, such as infrastructure, skills, and trade.”