LONDON (Reuters) – The Bank of England raised its key interest rate by a quarter of a percentage point to 4.5% on Thursday and Governor Andrew Bailey said the British central bank would “stay the course” as it seeks to curb the fastest inflation of any major economy.
The BoE is no longer predicting a recession after it made the biggest improvement to its growth projections since it first published forecasts in 1997.
But it now expects inflation – which remained above 10% in March – to fall more slowly than it had hoped, mostly due to unexpectedly big and persistent rises in food prices. It also saw stronger wage growth than it previously thought.
“We have to stay the course to make sure inflation falls all the way back to the 2% target,” Bailey said at the start of a press conference before stressing that the BoE was not sending any signals about its next moves, which would depend on data.
Policymakers voted 7-2 for May’s increase, in line with economists’ expectations in the Reuters poll, with Monetary Policy Committee members Silvana Tenreyro and Swati Dhingra again opposing further tightening.
GRAPHIC: Bank of England raises rates for 12th time in a row https://www.reuters.com/graphics/BRITAIN-BOE/dwpkdnjgzvm/chart.png
A Reuters poll last week showed most economists expected a 12th straight quarter-point rise in May – taking borrowing costs to their highest since 2008 – before a period on hold.
But investors have been betting on more increases and shortly after Thursday’s decision they were pricing in a peak of almost 5% this autumn.
“If there were to be evidence of more persistent pressures, then further tightening in monetary policy would be required,” the BoE said, maintaining its message from earlier this year.
The pound gained almost half a cent against the U.S. dollar, topping $1.26, while British government bond yields rose before settling back at roughly their levels before the announcement.
Paul Dales, chief UK economist at Capital Economics, said he thought rates were probably now at their peak but they might stay there until 2024 before being cut.
“We suspect that some stickiness in wage growth and domestic inflation will mean the holding phase of the cycle will be quite long and last until the first half of next year (by contrast we think the US Fed will cut rates this year),” Dales said.
Luke Bartholomew, abrdn senior economist, said upcoming inflation data releases – starting on May 24 with figures for April – could be “a source of market volatility especially around currency, with sterling now pricing in more aggressive action from the BoE from here compared to other central banks”.
The BoE was the first major central bank to start raising borrowing costs in December 2021, but was criticised by some for not moving aggressively enough as inflation headed towards a four-decade high of 11.1% struck in October.
Last week, the U.S. Federal Reserve and the European Central Bank both raised their benchmark borrowing rates by 25 basis points. While Fed Chair Jerome Powell hinted at a pause, ECB President Christine Lagarde said it was too soon to stop.
GRAPHIC: The race to raise rates https://www.reuters.com/graphics/GLOBAL-MARKETS/myvmowjmxvr/chart.png
Britain’s high inflation problem stems largely from its dependence on imported natural gas for power generation, leaving it particularly exposed to the surge in energy prices after Russia’s invasion of Ukraine last year.
Energy prices have now fallen sharply and the central bank expects inflation to drop to 5.1% by the end of this year from 10.1% in March. But this is less of a decline than the drop to 3.9% it forecast in February and the BoE predicts inflation will not return to its 2% target until early 2025.
Higher forecasts for food prices added about 1 percentage point to future inflation compared with February, the BoE said.
Most BoE policymakers saw “significant” upward risks to these inflation forecasts and inflation was not forecast to significantly undershoot its target at any point in the next few years, even if Bank Rate rises by another quarter point or more.
PAY GROWTH PRESSURES
The BoE is worried that recent strong headline pay growth could turn into a long-lasting problem for the economy, and on Thursday it forecast much stronger wage growth and lower unemployment than three months ago.
“Pay rates could plateau at rates above those consistent with the 2% inflation target sustainably in the medium term,” the central bank said.
BoE Chief Economist Huw Pill said last month that British businesses and individuals had to accept that their earnings had fallen in inflation-adjusted terms, triggering criticism from trade unions and some former BoE rate-setters.
The BoE forecast the economy would grow 0.25% this year – compared with its February prediction of a 0.5% contraction.
Cheaper energy, fiscal stimulus and improved business and consumer confidence mean the BoE now no longer predicts a recession this year, and expects the economy to be 2.25% larger in three years’ time than it did before.
The government’s budget announced in March was expected to boost economic output by around 0.5% over the coming years.
The BoE estimated that around a third of past interest rate hikes had fed through to households and businesses, a slower pass-through than in previous tightening cycles because of a higher share of homeowners with fixed rate mortgages.
Bailey said the extent of the impact on the economy of the BoE’s previous rates hikes was a “very lively subject of debate” among MPC members.
Source: Economy - investing.com
