Bank of England and Fed pump up interest rates again

While America’s Federal Reserve raised interest rates again by a further three-quarters of a point yesterday, the Bank of England boosted its rate by 50 basis points today in a split 5/4 decision.

The UK monetary authority’s Monetary Policy Committee voted five to four in favour of a 50 basis points jump in the base rate to 2.25%, with three members pushing for a 75 basis points increase and one believing that 25 basis points would be enough.

The BOE’s rate hike means UK base rates are now the highest level since December 2008.

Inflation predictions have changed as a result, with 11% rather than 13% now being forecast as the annualised increase.

Lee Evans of Bank of Ireland Global Markets noted that the MPC also voted in favour of selling UK gilts which has driven up UK 10yr interest rates close to 3.5%.

Evans added: “Interest rate markets are now also pricing in a 75bps hike at the next meeting in November, while there are still more than ten hikes priced in by the middle of next year. The ‘terminal rate’ – the expected high point in the interest cycle – is over 5% in the UK.”

Wealth Club head of equities Charlie Huggins described the Bank of England’s dilemma as “a horrible balancing act”.

“The MPC will feel its hand was forced. The new Tory government is opening the fiscal taps, while on the other side of the pond the Federal Reserve is tightening the monetary screws," said Huggins.

“Both factors have compounded pressure on sterling, which is trading at its weakest level against the dollar since 1985, and a weak currency only fans the flames of inflation, given the UK’s reliance on imports.

“The Bank of England is stuck between a rock and a hard place. A gentler approach to rate rises risks sending sterling into a tailspin, and seeing inflation get even further out of control.

"But too much tightening could easily choke the life out of the economy, without significantly easing the cost-of-living crisis. “It’s a horrible balancing act, with seemingly no good outcomes.

”The US rate increase by the Fed was its third 75 basis points jump in a row, and underlined chair Jerome Powell’s vow that he and his fellow policymakers would "keep at" their battle to beat down inflation.

Powell has effectively predicted that the rate rises may well bring recession, unemployment, and cuts in income to the US economy, but cites the housing market as a persistent source of inflation that is in need of a "correction".

The Fed has raised its benchmark overnight interest rate to a range of 3.00%-3.25%.

The widespread expectation is that there is another 1.25 percentage points in rate hikes to come in the Fed's two remaining policy meetings in 2022.

Powell said the Fed was "strongly resolved" to bring down inflation from the highest levels in four decades and that officials would "keep at it until the job is done" even at the risk of unemployment rising and growth slowing to a stall.

"We have got to get inflation behind us,” he commented. “I wish there were a painless way to do that. There isn’t."

Powell's grim words were echoed in London. The Bank of England estimates that the UK economy will shrink by 0.1% in the third quarter which, combined with a fall in output in the second quarter, meets the technical definition of a recession.

Nonetheless, the bank said it would continue to "respond forcefully, as necessary" to inflation, despite the economy entering a recession.

Before the decision to increase the rate to 2.5%, financial markets expected the bank to raise rates to 3.75% by year-end, with a 5% peak in mid-2023.

Less than a year ago, its rates were at a record low 0.1%.

Sterling fell to its lowest level against the dollar since 1985 following the Fed’s decision. And after the BoE’s announcement shares fell on the London exchanges.

Deutsche Bank senior economist Sanjay Raja commented: “The Bank of England delivered in line with expectations. The door is now open for a bigger hike in November, with the MPC explicitly acknowledging that should their updated outlook point to more persistent inflationary pressures, including from stronger demand, the bank stands ready to respond forcefully."