Will the Bank of England raise interest rates again this year?
- Bank of England held the base rate at 5.25% after a surprise drop in inflation
- Some economists believe interest rates have now peaked
The Bank of England has pressed pause on its rate hiking cycle, signalling its job might nearly be done after a surprise fall in the headline inflation rate. The Monetary Policy Committee voted to hold rates at 5.25 per cent, the first pause in nearly two years. Earlier this week, markets were confident the central bank would raise rates, but a cooler-than-expected inflation reading prompted speculation we could be near the end of the hiking cycle. The decision brings the BoE in line with its peers the ECB and the Federal Reserve, which held rates in its meeting on Wednesday but did not rule out further rises.
Today’s decision signifies the BoE could be nearing the end of its tightening cycle. So have we reached the peak, or could we be in store for further rate rises?
Why did the Bank of England hold the base rate?
Even before today’s decision, the Monetary Policy Committee had indicated we could be nearing the peak of the rate hiking cycle. Earlier this month, Andrew Bailey told the Treasury Select Committee: ‘I think we are much nearer now to the top of the cycle.’ He also expressed concern that if the bank hikes too far, then it might need to cut too quickly.
The MPC was split, with five members voting to hold rates while the remaining four voted to raise the base rate to 5.5 per cent. August’s inflation reading seems to have been the decisive factor in holding rates at 5.25 per cent, although the members who voted to hold also pointed to signs that the labour market is loosening. The majority judged that the greater risk is overtightening, before the full effect of previous interest rates has filtered through.
The MPC’s report, published alongside the base rate decision, said: ‘For most members within this group, the latest developments meant that the judgment to keep bank rate unchanged at this meeting rather than increase it was finely balanced.’
‘Given the significant increase in bank rate since the start of this tightening cycle, the current monetary policy stance was restrictive.
‘This meant that the decision on whether to increase or to maintain bank rate at this meeting had become more finely balanced between the risks of not tightening policy enough when underlying inflationary pressures could still prove persistent, and not placing sufficient weight on the impact of the previous tightening that was still to come through on activity and inflation.’
When the bank raises its rate, it can take up to two years for it to have a full effect on the economy. According to the committee, this lag in policy meant that ‘sizeable impacts from past increases were still to come through.’
Could there be another base rate rise this year?
The BoE’s neutral language and references to a ‘finely balanced’ decision suggest it won’t be a hard stop for interest rate rises just yet.
In his letter to the Chancellor, Andrew Bailey said: ‘There is absolutely no room for complacency. I can assure you that the MPC will stay the course and keep monetary policy sufficiently restrictive for sufficiently long to return inflation to the 2 per cent target in the medium term.’ Inflation still remains three times the level of the Bank’s long-term two per cent inflation target. The near-even split of its committee members in itself suggests another pause in November is not a given. The monetary policy lag means the Bank could be taking a ‘wait and see’ approach to see how previous rate rises have filtered through to the economy before the end of the year. It will also be looking at September and October’s inflation readings. Should core inflation start to rise again, it may take the decision to increase the base rate. The Bank said: ‘CPI inflation is expected to fall significantly further in the near term, reflecting lower annual energy inflation, despite the renewed upward pressure from oil prices, and further declines in food and core goods price inflation.
‘Services price inflation, however, is projected to remain elevated in the near term, with some potential month-to-month volatility.’
Bailey added: ‘Monetary policy will need to be sufficiently restrictive for sufficiently long to return inflation to the 2 per cent target sustainably in the medium term. Further tightening in monetary policy would be required if there were evidence of more persistent inflationary pressures.’
Paul Dales, chief UK economist at Capital Economics thinks this careful language is about the Bank wanting the markets to believe in the ‘high for long’ narrative.
‘The Bank doesn’t want the markets to conclude that a peak in rates will be quickly followed by a pivot to rate cuts, which would loosen financial conditions and undermine its attempts to quash inflation.
‘The language also gives the Bank the flexibility to respond to new developments.’
While the Bank may not be giving much away, some analysts believe that this will be the last rate hike in this cycle.
Both Dales and Samuel Tombs, chief UK economist at Pantheon Macroeconomics, believe interest rates have peaked at 5.25 per cent, rather than previous forecasts of 5.5 per cent.
‘With surveys pointing to a further increase in labour market slack, a slight slowdown in wage growth and lower CPI inflation by year-end, the case for hiking again likely won’t be stronger in November or December than today,’ said Tombs.
‘Accordingly, we now think that 5.25 per cent will be the peak level of bank rate in this hiking cycle.’
Dales said: ‘We think rates will stay at this peak of 5.25 per cent for longer than the Fed, the ECB and investors expect, but that when rates are cut in late 2024 they will be reduced further and faster than widely expected.’
By ANGHARAD CARRICK
21 September 2023
