The Bank of England will raise its benchmark rate to 4.75 percent on Thursday to combat an inflation issue that has grown more challenging and persistent in the last month.
Since the Monetary Policy Committee of the central bank began to raise rates in December 2021, the expected quarter-point increase will be the 13th consecutive rise in borrowing costs.
The UK’s April inflation rate was 8.7%, higher than the average for comparable economies. This is also far above the BoE’s target of 2 percent. The financial markets are increasingly convinced that the rate will only come down if interest rates increase sharply. This would hit mortgage borrowers like never before.
The “time bomb” of mortgage costs is now part of Britain’s long-term cost of living squeeze. Hundreds of thousands of households will face increasing costs when they leave fixed deals after 2024, the year of a likely general election.
On Monday, the pressure on Rishi and his government was increased when the rate of the fixed-rate mortgage for two years reached 6 percent.
Andrew Bailey, the governor of the BoE, is also under the spotlight for the performance of the central bank in controlling inflation. In the last six weeks, Bailey has had to admit that his bank underestimated the short-term inflation rate and that their forecasting model was not working correctly.
He also admitted that the bank had “lessons to be learned” in its conduct of monetary policies, and ordered a rapid review of forecasting and communication.
On Thursday, traders and economics will pay attention to the central bank’s statements as well as its actions, to get a sense of how high interest rates are likely to rise.
The Bank of England’s decision to make a rate cut will depend on the latest inflation figures for May, which were published this Wednesday.
The economists predict that the headline CPI will fall from 8.7% in April to just 8.5 percent, mainly due to price reductions in diesel. Core inflation, however, is expected to stay at 6.8% per cent. This is far higher than the central bank’s target of 2 percent.
The financial markets have already changed their outlook on interest rates due to the strong inflation and wage data that has been reported over the last month.
The official figures for last month show that CPI inflation dropped from 10.1% in March to 8.7% in April. However, this rate is far higher than the BoE’s expectations. This shows that the inflationary pressure is much greater than expected. Core inflation, which excludes food, energy, and alcoholic beverages, increased from 6.2% to 6.8% over the same time period.
The BoE’s failure to understand the price setting process was reinforced by the wage figures released last week. Average earnings grew at an almost record-breaking pace of 7.2% on an annualized basis between February and the end of April. It was evident that the UK had a stronger ratchet-effect on wages than other countries.
The BoE benchmark interest rate is expected to reach a peak of 5.75 percent by the end this year. This is a full percentage-point higher than what traders had predicted when the MPC met last on May 11.
The bad data and market movements over the last month have led economists to sharply revise up their expectations for interest rates. They are also more confident than usual that the MPC is going to raise them on Thursday.
Robert Wood, UK economist from Bank of America said: “All the indicators of inflation pressure the Bank of England had said it would closely monitor have either surprised to the upside or printed according to BoE forecasts.”
Samuel Tombs is the chief UK economist for Pantheon Macroeconomics. He said the BoE had no choice but to act after the April wage data and prices. He added that it was almost certain that the MPC would raise the bank rate on Thursday by 0.25 percentage point to 4.75 percent.
The central bank will be asked on Thursday by economists, politicians, and mortgage borrowers how far it thinks the interest rate rise should go.
Normaly, the BoE wouldn’t hold a press conference following the June meeting. The market fluctuations over the last month were so significant that Bailey was forced to make a comment.
He could reject the expectation of a further increase if he believes that the financial markets have priced borrowing costs to a level too high. As he did in November last year when said expected rates to rise by “less than currently being priced into financial market”.
This would undermine the credibility of the bank and make it appear too complacent in regards to inflation.
In contrast, if the central bank does not provide any guidance, mortgage rates could remain high, causing financial hardship for households and governments, and pushing the economy into a recession.
BoE observers believe the MPC will not comment on Thursday, and that they will continue to follow their current policy of raising rates if persistent inflation is demonstrated.
Bruna Skarica is a UK economist with Morgan Stanley. She said that she “did not anticipate a strong pushback against the market pricing” even though, in her opinion, BoE officials didn’t think it necessary to raise interest rates above 5%.
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