The Bank of England’s (BoE) Monetary Policy Committee (MPC) hiked interest rates by 50 basis points to 3.50%, in line with consensus forecasts.
As expected, there was a split within the committee as three members voted against the decision.
Mann favored a 75 basis point hike to 3.75% on concerns about ongoing inflationary pressures.
In contrast, Tenreyro and Dhingra both voted to keep rates on hold at 3.00%.
Gilts were bought following the decision, with the 10-year yield falling to 3.20% before recovering to 3.25%.
Sterling also lost ground, although the main move against the dollar came earlier in the session.
The pound-dollar (GBP/USD) exchange rate fell and tested 1.2300 before trading just above that pre-wall street level as the dollar lost ground.
The Pound to Euro (GBP/EUR) exchange rate fell to 1.1600 immediately after the decision.
The ECB also hiked interest rates by 50 basis points to 2.50%, but with more hawkish rhetoric than the BoE, stating that interest rates must continue to rise steadily and significantly. Following this decision, the GBP/EUR continued to fall to the December low of 1.1550.
Some relief for Q4 GDP
The government released its autumn statement shortly after the November political meeting.
According to the BoE, the overall impact will be limited with net GDP growth of 0.4% over 1 year and a contraction of 0.5% over 3 years.
GDP is now forecast to fall by 0.1% in the fourth quarter of 2022, compared to a 0.3% fall in November.
Stronger underlying inflationary pressures
Although inflation is expected to have peaked, there were still concerns that internal pressures would remain elevated.
According to the majority; “The labor market remains tight and there is evidence of inflationary pressures in domestic prices and wages, which may indicate greater persistence, thus warranting a further strong monetary policy response.
Both service price inflation and regular private sector wage growth picked up significantly in the second half of the year, with the latter continuing to surprise on the upside since the November report.
The majority also noted that the economy had been more resilient than expected in the November monetary policy report
The bank also expects, at this point in time, that interest rates will continue to rise in the coming months.
According to the MPC; “Should the economy develop broadly in line with the projections in the November monetary policy report, further interest rate hikes may be needed to bring inflation back to target on a sustainable basis.”
There were no comments that market prices were too high, although market prices have already fallen.
Following the decision, futures markets now expect rates to peak at 4.5%, compared to 4.6% before the decision.
Waste departments are intensified
There was also a split vote at the November session, but disagreements deepened in December.
According to Mann, who wanted a bigger rate hike, it was important to act briskly to keep medium-term inflation under control and avoid even higher rates down the road. She remarked; “Although there was some evidence of a turning point in CPI inflation, there were clearer indications that price and wage pressures would remain strong longer than forecast in the November report.”
However, Tenreyro and Dhingra believed the economy was already slowing sharply. They added; “The delays in the impact of monetary policy meant that significant impact from past rate hikes was yet to come. This implied that the current policy rate setting was more than sufficient to bring inflation back on target before falling below target in the medium term.”
According to Michael Hewson of CMC Markets; “It’s good that there is no groupthink at the Bank of England, but I wonder how anyone could think that a base rate of 3% is enough to sustainably bring inflation down from 10.7%, and let’s not even start with that at where the RPI is. ”
According to IoD Chief Economist Kitty Ussher; the BoE needs to be careful; “With the labor market starting to turn, the economy already shrinking and the base effects of last year’s price hikes expected to automatically lower next year’s headline inflation rate, it’s important that the bank does not tighten too much and risk prolonging the pain.
She added; “While today’s rise may be justified given the long lead time between rate hikes and the impact on demand, the bottom line is that we may soon be at the point where enough has been done.”
According to Joe Nellis, professor of world economics at Cranfield School of Management, the rate hike will stoke the fire for public sector wage increases.”
Even so, he added; “The Bank of England drug tastes bitter, but it’s the only option available at the moment.”
Ongoing debate on top rates
According to chief economist Ian Stewart; “The Bank of England has probably done about 80 percent of the monetary tightening it needs to do this cycle. Significant monetary tightening is permeating the system and will increasingly dampen growth in 2023.”
Capital Economics chief economist Paul Dales expects rates to have to rise to 4.5%.
According to Dales; “In our view, the majority of the MPC will want to see more concrete and significant signs that activity is slowing, the labor market is loosening and actual wage growth is slowing before rate hikes are halted.”
However, Dales anticipates significant easing in 2024; “The big difference is that we believe rates will cut further and faster in 2024 than markets are expecting.”
He expects interest rates to fall to 3.0%.
RSM UK economist Thomas Pugh also expects a high of 4.5%; “The minutes of the meeting made it clear that while the end is in sight, more hikes are ahead. We expect rates to rise to 4.5% early next year and not be cut again until early 2024.”
According to ING; “Today’s meeting is further evidence of the delicate balancing act the BoE faces between mitigating the risks of a tight labor market on the one hand and growing concerns about the housing market and the health of corporate borrowers on the other.”
It added; “We expect interest rates to peak at 4% in the new year, although we’re not yet convinced that a rate cut will follow as quickly as in the US.”
Samuel Tombs, UK chief economist at Pantheon Macroeconomics, also expects interest rates to peak at 4.00%.
Commerzbank expects the pound to struggle against the euro; “So far Sterling has resisted the euro. However, should the market find that the BoE faces a more difficult task maneuvering between inflation and recession than the ECB – as it stands – meaning the ECB will find it easier to continue its interest rate cycle, we expect to see rising EUR/GBP levels.”
ING expects GBP/USD to lose further ground; “Heading into the new year, we still see an overweight downside risk for GBP/USD as hawkish central banks (most notably the Fed) heading into recession point to the underperformance of high-risk sensitive currencies like the pound.”
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