A bus passes through the City of London financial district outside the Royal Exchange near the Bank of England on July 2, 2021 in London, United Kingdom.
Mike Kemp | In Pictures | Getty Images
LONDON – Markets expect the Bank of England to raise interest rates by 75 basis points on Thursday, its biggest increase since 1989, but economists believe policymakers will take a dovish tone looking ahead as the prospect of a recession deepens.
With UK inflation running at a 40-year high of 10.1% in September, the Bank is seen raising its key lending rate for the eighth time in a row, but weaker growth momentum and a major shift in fiscal policy are expected to dampen demand for more aggressiveness. financial tightening.
New Prime Minister Rishi Sunak has scrapped controversial tax cuts at the heart of Liz Truss’ previous fiscal policy agenda, meaning fiscal and monetary policy are no longer moving in opposite directions.
The government’s U-turn, which eased market tensions, means the Bank’s Monetary Policy Committee (MPC) does not have to contend with the additional inflationary effects of government policy, as it weighs the possibility of weaker growth ahead.
Goldman Sachs economists on Monday lowered their 2023 UK growth forecast from an annual rate of -1% to -1.4%, citing the possibility of less affordable household and business energy cost relief schemes under Sunak.
“Thus, we see less pressure for the BoE to act aggressively at next week’s meeting, but we still believe that an increase in rates to 75 basis points is likely given that (1) fiscal policy is more expansionary than assumed at the August MPR meeting; (2 ) news on the labor market and underlying inflationary pressures have been firm; and (3) MPC comments indicate a strong policy response at the November meeting,” Goldman economists said.
The Wall Street giant expects a split vote in favor of a 75-basis-point hike on Thursday with little chance of another half-point hike in December.
“We expect the MPC to explain the increase in the rate of increase with continued inflationary pressures and additional support to demand from the announced fiscal measures,” UK Chief Economist Stefan Ball and European Chief Economist Jari Stehn suggested.
“However, we do not expect significant changes to forward guidance and look for the MPC to maintain its meeting-by-meeting approach.”
Deutsche Bank also expect a split vote on Thursday in favor of a 75 basis point hike, taking the key interest rate to 3%.
In a note Friday, the German lender said it expected the MPC to deliver three key messages to markets.
The first is that the economic outlook is deteriorating and the UK economy is now facing a “deeper and more prolonged recession” than previously thought, while price pressures are likely to increase in the short term before falling into recession by the end of 2025.
“Second, policy is not a set path. Risk management considerations, however, call for further tightening and a front-load of rate hikes, given increased volatility in inflation (with the end of the Energy Price Guarantee scheduled for March 2023), an increase in price pressures, and wage increases as well as price growth next year,” said Deutsche Bank’s UK Chief Economist, Sanjay Raja.
“Therefore, policy needs to go further than expected, moving further into constrained territory, especially with inflation expectations declining, and second-round effects strengthening.”
The danger is too tight
The King also noted that there are limits to tightening monetary policy, suggesting that an eventual Bank Rate of 5% — as expected by the market — would result in balance sheet pressure for already struggling households and businesses.
“We expect the MPC, including the Governor at the press conference, to emphasize that while the Bank remains fully committed to combating excess inflation, it will try to avoid excessive corrections in rates that would put the economy back further from pre-pandemic levels,” Raja added.
Deutsche Bank now expects the Bank Rate to reach 4.5% by May next year, down from its previous projection of 4.75%, following a withdrawal of fiscal stimulus and a push towards fiscal consolidation.
Bank of England Deputy Governor for Monetary Policy Ben Broadbent said in a recent speech that GDP would receive a “fairly material” impact from the aggressive policy tightening. The Bank’s August growth forecast, already showing a five-quarter recession, is based on a much lower Bank Rate of around 3%.
“The new set of forecasts due, which are based on market interest rate expectations, are likely to be bleak — pointing to both a deep recession and inflation falling below target over the medium term,” said ING Advanced Markets Economist James Smith.
“That should be read as a not-so-subtle indication that the market price is inconsistent with achieving its inflation goal.”
Dovish Bank of England left the pound exposed
Having slumped to record lows against the dollar following Liz Truss’ disastrous fiscal policy announcement in late September, pound gained some time from the appointment of Sunak and the retention of the more moderate Finance Minister Jeremy Hunt.
If Thursday’s 75 basis point rise is accompanied by dovish rhetoric, as economists expect, sterling could be left vulnerable given the market’s overpricing of terminal rates, according to BNP Paribas.
“Given pressure in GBP shorts over the past week, a dovish BoE hike is unlikely to bode well for the currency. We therefore maintain GBP short heading into the meeting,” the French lender’s strategist said in a note Monday.