Giles Coghlan, chief analyst at HYCM said:
“With inflation sitting at a 30-year high of 7%, today’s dovish hike from the Bank of England (BoE) is a sign that policymakers are now entering increasingly choppy waters when it comes to controlling the inflation narrative. Generally speaking, the BoE does not want to see inflation entering strongly into wages. Once it does, the issue becomes systemic and generates a force of its own, which becomes exceedingly difficult to control. The so-called ‘wage-price spiral’.
“At the same time, today’s increase is not without risk: higher rates will inevitably place pressures on growth, as well as increasing cost burdens on U.K. households – the latter being an issue that many consumers are already having to grapple with. Given that energy prices are continuing to rise against a backdrop of continued geopolitical unrest, this fourth consecutive rate increase from the BoE presents the unique difficulties at hand for the Monetary Policy Committee.
“The task of reining in inflation without stomping out growth is a careful balancing act, and one that is already tipped in the favour of negative economic growth. Going forward, central bank-watchers can expect unemployment to rise gradually, as well as further modest hikes from the BoE, who are likely to accept the risks either way. This should keep EUR/GBP supported, with the European Central Bank looking increasingly likely to hike rates in July, and buyers on dips lower.”
Daniel Casali, Chief Investment Strategist at Tilney Smith & Williamson, the leading wealth management and professional services group which is set to re-brand to Evelyn Partners this summer, comments:
“The BoE decision to raise interest rates lies in the persistent above-target inflation readings, resilient job creation and overall economic growth momentum. In the near term, inflation risk expectations seem skewed to the upside and particularly in the context of a tight labour market and supply chain disruption from the war in Ukraine, sanctions against Russia and zero COVID policies in China. For instance, market-derived CPI inflation over the next year has risen to a record 10% at the end of April.
However, given the rising cost of living, a rise in National Insurance and previous rate increases, the MPC will still be mindful of a potential abrupt slowdown in consumption later this year and into 2023. The Office of Budget Responsibility forecasts that household disposable income will fall 2.2% in the 2022/23 fiscal year. If realised this would mark the biggest fall in take-home pay since the 1950s. The fact that retail sales in March materially disappointed consensus expectations is a warning sign that consumers are paring back expenditure somewhat.
Even so, the BoE is still likely to maintain a tightening bias and leave open the possibility of an interest rate increase at its June MPC. Future rate increases will be dependent on ongoing labour market tightening and intensifying near-term cost pressures. The money markets expect the UK overnight interest rate (a proxy for the base rate) to reach around 2.5% in 12 months’ time from 1.0% today.
The MPC also made clear that it is working on a plan to start Quantitative Tightening (QT) later in the year. Although the BoE has already commenced a passive reduction of its balance sheet by selling corporate bonds, it now plans to start the sale of gilts bought since the Global Financial Crisis more than a decade ago. The BoE is really introducing QT to shore up its long-term credibility with markets, rather than as an additional tool to combat elevated inflation.
For investors, a rising interest rate environment is likely to be relatively beneficial for a value-focused market like the UK.”
Katharine Neiss, chief European economist at PGIM Fixed Income, adds:
“The BoE is in arguably the most difficult situation among major central banks. With inflation expected to peak in the double digits by year-end and growth likely to more than halve into next year, according to the central bank’s latest forecasts, it is the prospect of prolonged above target inflation that is driving policy decisions for now.
With the bank rate at 1%, BoE staff will begin a review on active bond sales in time for August. We expect some tentative active selling of government bonds by the central bank before the year is out, but rates may be nearing a peak as signs of a slowing UK economy begin to snowball. However, risks remain that the central bank gets pushed into setting even higher rates into a recession, as a depreciating pound puts further upward pressure on headline inflation.”
