While Andrew Bailey, governor of the Bank of England, has been waxing lyrical about a potential 0.5 percentage point increase in interest rates, his message to the market is somewhat confusing. In a recent speech, he pointed to increased inflationary pressures in the short term and the need to rein in inflation, which could peak at double-digits. Then in the same breath, he countered that a 0.5% increase in interest rates is “not locked in”. Confused?
We know that the next Monetary Policy Committee (MPC) meeting will bring an increase in base rates, but opinion is split as to the size of it. The consensus still seems to be a 0.25% increase, taking UK base rates to 1.5%, although there is growing momentum behind the need for a 0.5% increase.
ECB and Federal Reserve announced significant hikes
Recently, the European Central Bank (ECB) and Federal Reserve announced significant hikes in their interest rates to tackle consumer spending and inflationary pressure. Consequently, pressure is growing on the Bank of England to be bold and announce a 0.5% increase, which has already been discussed in previous meetings. As we have seen with recent exchange rate movements, a failure to keep pace with overseas central bank interest rate increases is placing pressure on sterling.
Further inflationary pressure
In the short-term, inflation is expected to peak in double digits with the economy doing better than expected and employment growing strongly. We are in the bizarre situation where the economy appears to be doing well, but underneath, inflation is gnawing away at relative spending power. In addition, labour shortages are pushing wage inflation higher, with public and private sector employers forced to push back on inflation-busting wage rises. Inflation needs to be brought under control as soon as possible!
How high might interest rates go?
While some analysts believe that interest rates could top 3% in early 2023, with at least two 0.5% increases by the end of 2022, this is not the consensus. Balancing the potential risk of recession against the immediate need to tackle inflation, interest rates may not reach the 3% mentioned by some observers. It is also debatable whether a 0.5% increase this week would signal a new, more aggressive stance from the Bank of England or a short sharp shock, followed by smaller increases.
Is the Bank of England being dragged along?
Critics of the Bank of England will point to the second half of 2021 when inflationary pressures started to emerge. At that time, the MPC was reluctant to make any significant move on interest rates, taking a wait-and-see approach. However, consistently behind the curve towards the end of 2021, the MPC was forced to carry out a U-turn and moved towards a more aggressive monetary policy. There are concerns that the Bank of England is being dragged along by the likes of the ECB and the Federal Reserve, which have both been more aggressive in the short term.
We could see the most considerable rate hike in 25 years
It is fair to say that the Bank of England MPC has disappointed analysts with their take on inflation and interest rates over the last 12 months. So might the MPC take the bull by the horns this week and introduce a short sharp shock with a 0.5% rise in interest rates?
The consensus is no, but…