Investors have pared back their expectations for further rises in UK interest rates after the Bank of England warned the economy would stall at the end of the year as double digit inflation squeezed household incomes.
While the US Federal Reserve and European Central Bank policymakers have signalled that they are likely to move aggressively to rein in soaring inflation, the message from the BoE’s Monetary Policy Committee following Thursday’s rate rise was more ambiguous.
A majority of the committee still felt “some degree of further tightening” was likely to be needed in the coming months — and three members voted to raise interest rates by 50 basis points this week, rather than the 25 basis point move the MPC settled on. But two members thought the worsening growth outlook made it unclear if any further moves would be needed.
Huw Pill, the BoE’s chief economist, said on Friday that these differing opinions on the committee reflected the “narrow path” it was trying to steer “between the inflationary risk . . . and the risk of unnecessary weakness in activity and employment on the other side”.
The BoE’s new forecasts, set out alongside the central bank’s policy decision, suggest that although inflation is set to climb above 10 per cent in the autumn, when energy prices rise again, it would fall well below the 2 per cent target by 2025 if interest rates were to rise in line with recent market expectations.
Paul Hollingsworth, economist at BNP Paribas, said this was a “clear warning sign that markets have gone too far in their expectations for rate hikes over the coming quarters”, adding that the MPC’s forecast of rising unemployment and near-stagnation in GDP in 2023-24 was “a far cry” from the Federal Reserve’s relatively robust outlook for the US economy.
In the run-up to Thursday’s decision, market pricing implied the BoE would raise interest rates to 2.25 per cent by the end of the year, with its benchmark rate peaking at 2.6 per cent in 2023. By Friday, investors’ views had changed, with pricing suggesting one fewer rate increases over the course of 2022 and rates peaking closer to 2.5 per cent next year.
Analysts at RBC Capital Markets said the BoE’s pessimistic outlook could prove to be “a tipping point” where investors switched their focus from high inflation to deteriorating growth, and had “at least begun to consider that the window for tightening may be closing”.
Anna Titareva, economist at UBS, said the forecasts suggested that the BoE was “unlikely to up the tempo on the pace of hikes given the weakening growth outlook” and that “its terminal rate would be lower than current market pricing and what the Fed would eventually deliver”.
The peak in UK inflation will come later than in the US or the eurozone because its six monthly adjustment of regulated energy prices means the impact of the Ukraine conflict on oil and gas markets has not yet fully fed through to consumers.
Pill said the coming hit to real incomes would be “a very large squeeze reflecting a very large shock to the economy”, and that some parts of society would inevitably lose spending power. “I don’t want to downplay the magnitude of the shock the UK is facing and the fact that this will have adverse consequences in terms of growth, inflation and ultimately real incomes,” he added.
Source: Economy - ft.com
