Bank of England to increase interest rates by 5.5%

The financial markets and economists expect the Bank of England will raise interest rates another quarter point during its meeting on Friday, bringing the cost of borrowing up to 5.5%, its highest rate since early 2008.

The increase would be in line with a similar move by the European Central Bank (ECB) last week. This is despite comments made by BoE ratesetters over the past few months that were intended to give them an option to keep rates at 5,25 per cent.

In the recent wage data and the cost of service data, the BoE has stated that it will raise rates if further signs of inflation persist.

This evidence is at odds with the signals that have been coming from Threadneedle street in recent weeks. The Monetary Policy Committee of the bank has been trying to cast doubt on the decision made in September, now that borrowing rates are high enough to impact economic growth and inflation.

Huw Pill, BoE’s chief economist, said that inflation would drop if BoE increased rates and then cut them as the financial markets anticipate, or if BoE stopped and maintained current rates for a long period of time. He said that he ” tended[ed] towards”, the latter.

In evidence given to MPs in this month, BoE Governor Andrew Bailey and Sir Jon Cunliffe both agreed that the interest rates are ” closer to the top of cycle”.

Swati Dhingra is a fourth MPC member who believes that interest rate has already gone too far. She also thinks there’s a risk of excessive tightening.

The BoE should not pause the rate hikes immediately, even though four out of nine MPC members said they weren’t sure that rates need to be raised further.

In August, the BoE forecasts were far exceeded by the private sector’s 8.1% wage growth in the 12 months to July. The services inflation rate of 7.4% was also well above.

The 15th rate increase in this cycle may well be the final one. Paul Hollingsworth is the chief Europe economist for BNP Paribas. He said that he expects “a dovish increase” to 5,5%, along with guidance from the majority of committee members who believe rates do not need to be raised further.

Capital Economics stated that a quarter point rise “will mark the end of this cycle”, while Deutsche Bank noted that the BoE’s rate hike to 5.5% on Thursday “opened the door for a break”.

The financial markets are now taking the same position. They still priced in a quarter point rise in rates for Thursday at the end of the last week and considered this to be the current peak. After the MPC meeting in August, the markets still expected rates to reach 5,75% this year.

Krishna Guha said, Evercore ISI vice-chair, that despite a coordinated effort to convince everyone that there was no more need for rate increases, the data still did not justify a pause.

The August inflation data will be released early on Wednesday morning, one day before the BoE’s rate decision.

As a result, the rate of price increase is expected to rise by about 7.1 percent. This is due to a recent rise in the prices of petrol and diesel as well as an increase in alcohol duty.

Policymakers are unlikely to be concerned by the slight increase in inflation because the forecasts for August were already in place. However, the MPC will pay close attention to the data in the service sector.

Central bank officials consider the price increases of domestic services – especially in areas like restaurants and hotels – as an indication of inflationary pressures. The MPC would need to see a dramatic improvement in August’s data before it could vote to pause.

MPC is likely to ignore other major developments in economic data from the last month, according to economists. The revisions which showed that the UK economy performed nearly 2 per cent better in 2020 and 2021 than originally thought were not likely to affect the MPC’s views on inflationary pressure.

Andrew Goodwin is the chief UK economist for Oxford Economics. He said that the upgrades are more likely to influence policymakers’ perceptions of how quickly the economy can grow without creating more inflation than they will make them believe there are greater price pressures this coming year. He said that it was not certain whether the revisions would affect the MPC’s stance on rates.

The MPC, along with deciding on the rate, must also decide the number of gilts that the BoE intends to sell over the next year as part of its quantitative tightening.

It is an annual, one-off event that takes place in September to provide the government bond markets with certainty regarding the supply of gilts. In the last 12 months, the bank has shed £80bn off its balance sheet. This is made up of £34bn sales and £46bn maturing gilts.

Sir Dave Ramsden (BoE’s deputy governor for Markets) has stated that he expects the quantitative tightening to be greater than £80bn over the next twelve months. He had previously stated that the £34bn of gilt sales in the years 2022-23 would not have a material impact on borrowing costs, as the amount was so small in comparison to the £252bn of gross financing required by the government this year.