- The Bank of England (BoE) raised the Bank Rate by 50 basis points (bps) to 4.00% in a split 7-2 vote as a tight labour market and continued domestic wage and price pressures justified a tenth consecutive increase.
- While UK consumer price index (CPI) inflation is thought to have peaked, risks remain skewed significantly to the upside as updated growth projections point to a shallower recession than previously forecast.
- The outlook for the economy remains highly uncertain and, in turn, the future path of interest rates is now largely data dependent.
Another split decision
At their first meeting of 2023, the Monetary Policy Committee (MPC) raised the Bank Rate by 50bps to 4.00%, the highest level since November 2008 (Exhibit 1), an increase that was largely expected by the market. Seven MPC members voted in favour of the immediate increase as economic activity remains resilient and inflation elevated; while two members – Dhingra and Tenreyro – dissented with a vote for rates to remain unchanged, suggesting base rates were already sufficiently restrictive.
Notably, the MPC did, in the accompanying statement, amend two key aspects of its forward guidance: They removed the reference requiring “future forceful monetary policy response”, instead stating that “future rises might be necessary if the economy evolved as expected”. And secondly, they confirmed they will “continue to monitor closely indications of persistent inflationary pressures for evidence of more persistent pressures to determine if further tightening in monetary policy would be required”.
Exhibit 1: UK bank rate at 4.00% for first time in nearly 15 years
Inflation risks skewed to the upside
Headline inflation has been falling – from a peak of 11.1% in October 2022 to 10.5% in December – as wholesale gas prices have moderated and global supply chain disruption has eased. Further declines are expected over the coming months as the lagged effects of past rate hikes and base effects drop out of the calculation. The February Monetary Policy Report (MPR) now projects that CPI will fall below the 2% target in Q2 2024 (Exhibit 2), based on a market path for interest rates
However, the MPC also noted significant upside risks to this outcome. Firstly, energy prices may not continue to fall by as much as currently predicted and, secondly, domestic UK price pressures have been somewhat stickier than expected with tightness of the labour market potentially leading to further second-round effects in price and wage setting.
Exhibit 2: Bank of England modal CPI inflation forecast (% year-on-year)
Evolution of the economy will be key
Uncertainty also exists around the outlook for the economy. Supply-side growth is expected to be weaker than historical levels, and while demand-side consumption should be supported by lower redundancies, the combination of higher prices and lower real wages are likely to negatively weigh on growth. The BoE continues to forecast a technical recession for the UK – two consecutive quarters of negative growth – later in 2023 (Exhibit 3). However, the decline in GDP is likely to be shallower than previously expected and significantly shorter than previous recessionary periods over the past few decades.
Exhibit 3: Bank of England modal GDP forecast (% year-on-year)
The latest rise in rates will augment returns for sterling cash investors in the coming weeks, as deposit and short-term investment yields reset higher. Currently, market pricing suggests the BoE (Exhibit 4) is nearing the end of its current rate hiking cycle and may even start to cut rates later this year. However, the path for interest rates remains unpredictable, exacerbated by ongoing geopolitical tension, an uncertain outlook for inflation and persistent government borrowing.
Against this uncertain backdrop, we expect sterling cash investors to adopt a cautious and disciplined investment approach to cash segmentation, prioritising a combination of money market and ultra-short duration strategies, with the goal of continuing to optimise returns without excessively increasing risk or volatility.
Exhibit 4: UK SONIA forward curves are projecting cuts to the Bank Rate