Bank of England raises interest rates by 50 basis points and now sees a “much shallower” recession than feared

LONDON – The Bank of England on Thursday raised interest rates by 50 basis points, dialing back some of its earlier gloomy economic forecasts.

The Monetary Policy Committee voted 7-2 to one second interest rate increase by half a point in a row, which took the central bank’s interest rate to 4%, but indicated in its decision statement that smaller increases and an eventual end to the hiking cycle may be on the cards at future meetings. The two dissenting members voted to leave the rates unchanged at this meeting.

Crucially, the bank also dropped the word “strong” from its rhetoric about continuing to raise interest rates as needed to rein in inflation. It sees an upcoming easing in the annual consumer price index:

“Annual CPI inflation is expected to fall to around 4% towards the end of this year, along with a much shallower expected decline in output than in the forecast from the November report,” the bank said.

“In the latest modal forecast, conditional on a market implied rate for the bank rate rising to around 4½% in mid-2023 and falling back to just over 3¼% in three years, there is an increasing degree of economic slack, alongside falling external pressures, cause CPI inflation to fall below the 2% target over the medium term.”

However, the MPC noted that the labor market remains tight and that domestic price and wage pressures have been stickier than expected, suggesting risks of “greater persistence in underlying inflation.”

Inflation in the UK reached 10.7% in December, down slightly from the previous month’s 41-year high of 11.1%, as easing fuel prices helped ease price pressures. However, high food and energy prices continue to put pressure on British households and drive widespread industrial action across the country.

Improved economic outlook

The bank on Thursday revised its economic outlook to predict a shorter and shallower recession than previously indicated in the November projections.

The economy is now expected to contract slightly through 2023 and the first quarter of 2024 as energy prices remain high and rising market interest rates constrain spending. Four-quarter GDP is expected to have fallen by 0.3% through the first quarter of 2023 and is expected to fall by 0.7% in the first quarter of 2024, compared with the 2% forecast in November.

The bank previously predicted the UK economy was heading into its longest ever recession, but GDP unexpectedly grew by 0.1% in November after also beating expectations in October, suggesting the impending recession may not be as long or as deep as previously feared.

However, the International Monetary Fund on Monday downgraded its projection for UK GDP growth in 2023 to -0.6%, making it the world’s worst-performing major economy, behind even Russia.

Prices are approaching a peak

Sterling fell 0.7% against the dollar, and gold plated Interest rates fell as the central bank signaled interest rates were nearing a peak while leaving the door open for further tightening if needed.

“With a softening of the labor market and inflation beyond its peak, there does not seem to be a good reason to tighten interest rate policy further, and don’t forget that quantitative tightening is still happening in the background,” said Boris Glass, senior economist. at S&P Global Ratings.

“The BoE went from virtually zero to 4% in quick succession. These much higher rates have yet to show their full effect on the economy and specifically inflation.”

Glass also highlighted the potential impact on the housing market, with UK mortgage holders now facing the “double whammy” of high inflation and much higher mortgage costs. S&P Global believes the bank will now pause to monitor the knock-on effects its tightening to date has had on inflation and the wider economy.

“Wages inflation has been stubbornly high, albeit well behind inflation, but that is what keeps higher inflation going forward and is a key concern for the BoE, so it will be watching the labor market and wage growth closely over the next few years. months,” Glass added.

Hussain Mehdi, macro and investment strategist at HSBC Global Asset Management, also suggested the bank’s prime rate is now “near its peak”, with the growth outlook “still soft” despite the upward forecast revisions.

“The big question now is the speed with which the MPC can reverse the course of interest rates. A downside risk to markets and the economy is a long period of restrictive policy to deal with persistent underlying inflation,” Mehdi said.

“We maintain a cautious view on UK and European equities in light of downside risks to GDP and corporate earnings growth relative to consensus expectations, and believe the recent rally is unsustainable.”