Daily Management Review

Bank Of England Is Set To Raise Interest Rates By The Most In 33 Years


Bank Of England Is Set To Raise Interest Rates By The Most In 33 Years
The Bank of England is expected to raise borrowing costs by the most since 1989 next week, even as it prepares for a recession that could be exacerbated by spending cuts implemented by new Prime Minister Rishi Sunak.
In addition to raising interest rates for the eighth time in a row on Thursday to tame inflation above 10% - this time by three-quarters of a percentage point, according to most analysts - the Bank of England is also set to become the world's first major central bank to begin selling bonds from its stimulus stockpile on Tuesday.
Following a period of turmoil in Britain caused by former Prime Minister Liz Truss's economic plans, which sparked a bond market rout, the Bank of England's double-barreled monetary tightening may appear at odds with its current forecasts that the economy will contract until 2024.
However, with inflation still expected to be well above the Bank of England's 2% target in 2023 and some of Truss's costly assistance for households and businesses still in place, borrowing costs can only go up.
"As things stand today, my best guess is that inflationary pressures will require a stronger response than we perhaps thought in August," BoE Governor Andrew Bailey said on Oct. 15.
The Bank of England raised interest rates by half a percentage point on August 4, the largest increase in 27 years, and did so again in September.
Bailey's inflation concerns were alleviated two days later when new finance minister Jeremy Hunt reversed almost all of Truss's tax cuts and reduced her income-boosting energy cap program to six months rather than two years.
However, the ongoing spread of inflation throughout the British economy this year means the Bank of England remains on high alert.
According to Oxford Economics Chief Economist Andrew Goodwin, the Monetary Policy Committee is still juggling a difficult balancing act.
"Many economic indicators have weakened since the committee last met in September, but the jobs market has remained tight and pay growth strong," Goodwin said.
Investors expect a 75 basis-point increase in the Bank Rate to 3% on November 3. That would be less than the full percentage point predicted before Truss' plans were scrapped, but it would still be the largest increase by the BoE in 33 years.
According to a Reuters poll of economists published on Tuesday, the majority expected a 75 basis-point increase, with a sizable minority expecting a larger increase to 3.25%. ING analysts predicted a smaller, 50-basis-point increase on Friday.
The future picture is clouded by the postponement of Sunak and Hunt's plans to repair the public finances.
They have forewarned of difficult decisions. The British media reported that they were considering 50 billion pounds in tax increases and spending cuts, which would be more than estimates of the budget gap.
Hunt was supposed to make the announcement on Oct. 31, but it was postponed until Nov. 17 after Sunak became prime minister.
Investors are much less concerned about inflation than they were just a few weeks ago, with Bank Rate expected to peak at around 4.75% in 2023, down from more than 6% prior to the abrupt end of "Trussonomics."
On Oct. 20, Deputy Governor Ben Broadbent poured cold water on the economy, saying that borrowing costs priced by investors in the previous days would hammer it.
The Bank of England's plan to begin selling some of the bonds it has purchased to support the economy since 2009 will also relieve some of the pressure to raise interest rates.
According to Deutsche Bank, the planned 40 billion pound sales over the next year are equivalent to about 25 basis points of rate hikes.
However, Goodwin of Oxford Economics warned of potential risks in the plan. "There is no compelling reason to begin quantitative tightening, and bond sales risk causing renewed turmoil in the gilts market," he said.