Bank of England hikes rates by 50bps and now sees a ‘much shallower’ recession than expected

LONDON — The Bank of England raised interest rates by 50 basis points on Thursday and recalled some of its previous bleak economic forecasts.

The Monetary Policy Committee voted 7-2 in favor of a second consecutive half-point rate hike, bringing the main discount rate to 4%, but said in its decision statement that smaller increases and a possible end to the upward cycle could be on the agenda. cards at future meetings. The two dissenting members voted to leave the rates unchanged at this meeting.

Crucially, the Bank has also dropped the word “forcefully” from its rhetoric around continuing to raise rates if needed to get inflation under control. It predicts an upcoming easing of the annual consumer price index:

“Annual CPI inflation is expected to fall to around 4% towards the end of this year, alongside a much less pronounced decline in output than projected in the November report,” the Bank said.

“In the latest modal forecast, conditioned by an implicit market path for the discount rate that rises to around 4½% in mid-2023 and falls back to just over 3¼% three years from now, an increasing degree of economic slowdown , along with falling external pressures, is leading CPI inflation to fall below the 2% medium-term target.”

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

UK inflation stood at 10.7% in December, down slightly from the previous month’s 41-year high of 11.1% as lower fuel prices helped ease pressures on prices. However, high food and energy prices continue to weigh on UK households and trigger 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 predicted 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 limit spending. Four-quarter GDP is forecast to have contracted 0.3% through Q1 2023 and is expected to contract 0.7% through Q1 2024, from 2% forecast in November.

The Bank had previously predicted the UK economy was entering its longest recession on record, but GDP unexpectedly rose 0.1% in November after also beating expectations in October, suggesting the impending recession might not be as long or as deep as previously feared.

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

Prices close to a peak

Sterling fell 0.7% against the dollar, and Golden yields fell as the central bank signaled that rates were approaching a peak, while leaving the door open for further tightening if needed.

“With the labor market slowing and inflation past its peak, there doesn’t seem to be a good reason to tighten rate policy any further, and remember that quantitative tightening always happens backwards. -plan,” said senior economist Boris Glass. at S&P Global Ratings.

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

Glass also flagged the potential impact on the housing market, with UK mortgage holders now facing the “double squeeze” of high inflation and much higher mortgage costs. S&P Global believes the Bank will now pause to monitor the ripple effects its tightening to date has had on inflation and the broader economy.

“Wage inflation has been stubbornly high, albeit well below inflation, but that’s what keeps higher inflation going into the future, and that’s a major concern for the BoE , so it will be watching the labor market and wage growth closely in the coming months,” Glass added.

Hussain Mehdi, macro and investment strategist at HSBC Global Asset Management, also suggested that the main discount rate is now “near its peak”, with growth prospects “still soft” despite upward revisions to forecasts.

“The big question now is how quickly the MPC can reverse course on rates. A downside risk to markets and the economy is a long period of tight policy to deal with persistent underlying inflation,” said Mahdi.

“We remain cautious on UK and European equities amid downside risks to GDP and corporate earnings growth relative to consensus expectations, and believe the recent rally is unsustainable.”