Bank of England to increase interest rates to highest since 2008

In the wake of data released last month showing that inflation was still high, the Bank of England will raise interest rates on Thursday to their highest levels since 2008.

This would be the 12th consecutive increase by the central banks since they began raising rates in December 2020. The move follows similar ones by the US Federal Reserve, and the European Central Bank.

The Monetary Policy Committee will use its messaging on future tightening, which was well balanced at its last meeting in march, as well as the new economic projections, to determine how much interest rates can still rise.

The markets and economists almost unanimously anticipate a quarter-point increase, from 4.25 to 4.5 percent.

After the MPC’s March meeting, the committee stated that it would monitor “evidence” of persistent [inflationary] forces before increasing rates.

Inflation in March, according to official data, was 10.1%, which is higher than the BoE forecast in February, when the BoE expected a decline to 9.2%. The economists say that the threshold of evidence has been met, combining a rise in wage pressures with stronger economic data.

Bruna Skarica is a UK economist with Morgan Stanley. She believes that the figures for inflation are a game changer, thanks to “stickiness of core goods [inflation] despite relatively low retail sales volumes”.

George Buckley, Nomura’s chief UK economist, said that the odds of the BoE not raising rates by 25 basis point were “very low”. He said: “Pricing indicates that markets think the same.”

The BoE will start with the higher-than-expected inflation rate for march. Officials are expected to continue to predict that price pressures will decrease quickly by 2023, as the sharp increase in energy prices last year is no longer included in the annual comparison.

The MPC’s expectations for inflation will fall even faster in May than they did in February, despite the fact that the initial rate will be higher. In turn, this would increase household incomes.

The current spot price for natural gas is 82p per therm. This is less than half the 189p price that the BoE forecasted in February 2023. The current price of the futures contract for late 2024 is 147p per therm, down from 174p a few months ago.

Buckley said that the BoE’s forecast of a recession in the economy this year would be scrapped due to the decline in energy prices.

A better outlook could also be a problem for a central bank, as it would need to explain to the public why they are raising interest rates while their central forecast in its model is likely to indicate lower inflationary pressures over the medium term.

Officials will defend this approach with signs of “second round” effects, which is economists’ jargon and what most people refer to as a wage-price cycle. These effects are not clearly defined in the BoE model. Jumana Saleheen is chief economist at Vanguard Europe and she said that some MPC members “underestimated” the transmission of recent high inflation rates into the economy.

In February, officials began to see problems with the model of the central bank when they decided to add an extra 0.8 percentage points in order to create what they called an “arithmetic-mean” risk-weighted forecast. This led to the biggest ever deviation from the MPC central forecast.

The adjustment factor could be greater this time around, according to economists. This is due to concerns expressed by some members of the committee that high inflation has become more embedded in daily life and company pricing decisions.

The MPC is not going to want to limit its options and exclude future rate increases. Officials will signal that future rate movements are “data-dependent” and that they have no bias towards tightening the policy or reversing and lowering interest rates.

MPC members are increasingly concerned about the danger posed by an upward spiral in wages and prices. Huw Pill, chief economist at the BoE, told companies and households late last month that they had to “accept” that their lives were now poorer due to higher energy costs. Officials from the central bank have stated that they are closely monitoring companies’ pricing decisions.

Ashley Webb of Capital Economics in the UK said that the MPC had a responsibility to communicate the need to increase the cost of borrowing by companies and households, rather than to encourage people to refrain from asking for raises or to protect profit margins.

Since the bank began to increase interest rates in December 2021 from 0.1 percent to 4.25 percent, it has warned repeatedly that rates would not rise very much. He said that if the bank had been more hawkish about interest rates, then perhaps wage and price expectations would have fallen further.

The MPC will also discuss the risks it faces in making its interest rate decision, given the uncertainty.

Jagjit Chadha is the director of the National Institute of Economic and Social Research. He said that the MPC “has always taken a risk based approach or should have” to “minimize the probability of large and persisting errors”.

Silvana Tenreyro is a member of the external committee who consistently votes against rate increases. If the MPC raises rates too much before economic growth and inflation take effect, MPC members will look like “fools” in the shower, she said. She warned that tightening monetary policy further could lead to a severe downturn.

The hawks are concerned that the MPC may act too slowly, and fail to bring inflation anywhere near BoE’s target of 2 percent.

Financial markets were a better predictor of interest rate increases in the short term than economists and BoE officials for most of the time since rates began to rise.

The futures market indicates that borrowing costs are expected to finish the year close to 5%.