In Brief

• The Bank of England (BoE) raised the Bank Rate by 25 basis points (bps) to 4.50% in a split 7-2 vote as the Monetary Policy Committee (MPC) believes persistent inflationary pressures and a tight labour market justified a twelfth consecutive increase.
  
  
• Stronger global growth and lower energy prices, combined with fiscal support and an improvement in UK activity have led to a more favourable economic outcome than previously forecast.  However, inflation has been higher than expected due to rising prices for core goods and food.
  


• The outlook for the economy remains uncertain and while the BoE’s confirmed the future path of rates will be data dependent, inflation risks remain to the upside.

MPC split 7-2 – again

At its May 2023 meeting, the Monetary Policy Committee (MPC) raised the Bank Rate by 25bps to 4.50%, a new 15-year high (Figure 1). The increase was largely expected given that CPI (consumer price index) inflation remained elevated at 10.2%y/y in Q1 2023, alongside a persistently tight labour market. Seven MPC members voted in favour of the immediate increase, citing “the risk of more persistent strength in domestic price and wage setting, as represented by the upward skew in the projected distribution for CPI inflation”.  Similar to the March meeting, two members – Dhingra and Tenreyro – dissented with a vote for rates to remain unchanged, suggesting base rates were already sufficiently restrictive with lagged effects from past rate increases still yet to feed through.

Figure 1: UK Bank Rate at 4.5% for the first time since October 2008

Source: Bank of England, as at 11 May 2023.

So long, recession

Despite recent global banking sector volatility, global growth continued to be stronger than forecast following the end of China’s zero-Covid policy, and resilience in both the euro-area and US economies. This strength combined with stronger domestic demand, lower energy prices and fiscal support measures introduced by the UK government in the Spring Budget, encouraged the BoE to lift their GDP economic forecasts to 0.25% in 2023 and 0.75% in 2024 – compared to -0.5% and -0.25% respectively in the February Monetary Policy Report. With first quarter GDP printing at 0.1%q/q, the UK is now expected to avoid a technical recession with quarterly growth projected to stay above zero (Figure 2).

Figure 2: Bank of England modal GDP forecasts (% year-on-year) were revised significantly higher

Source: Bank of England, as at 11 May 2023. Forecasts are not a reliable indicator of future performance.

Hello skew

Inflation remains stronger than the BoE expected – 12 month CPI printed 10.2% in Q1 2023 – reflecting upside surprises and core goods prices, while services inflation and wage growth have been elevated but close to expectations.  In addition, continued labour market tightness and a lower projected path of unemployment could also pose a risk of domestic price pressures from second-round effects. This suggests inflation may fall at a slower pace than previously projected, remaining above the Bank's 2% target until around the end of 2024 and then declining towards 1% in the medium term (Figure 3).  The MPC noted “there remain considerable uncertainties around the pace at which CPI inflation will return sustainably to the 2% target” and “that the risks around the inflation forecast are skewed significantly to the upside”.

Figure 3: Bank of England modal CPI inflation forecast (% year-on-year)

Source: Bank of England, as at 11 May 2023. Forecasts are not a reliable indicator of future performance.

MPC closing comments were hawkish with the central bank committed to ensuring “CPI inflation will return to the 2% target sustainably in the medium term”. However, given the uncertain economic outlook, policy makers maintaining their previous guidance to “continue to monitor closely indications of persistent inflationary pressures” to determine if “further tightening in monetary policy would be required”.

Investor implications

Sterling cash investors welcome this further increase in Bank Rate as improved overnight rates will boost returns for liquidity strategies – albeit with a slight delay due to the need to reinvest term maturities – while ultra-short-term cash strategies are also well-positioned to capture the uplift in overnight rates.

While the market anticipates the BoE may be nearing the end of its current rate hiking cycle (Figure 4), the path for interest rates remains unpredictable, exacerbated by ongoing geopolitical tension, volatility in overseas banking sectors, an increasing emergence of economic slack and an uncertain outlook for inflation.

Against this uncertain backdrop, we expect sterling cash investors to adopt a cautious and disciplined investment approach to cash segmentation, prioritising a combination of diversification and liquidity.

Figure 4: UK SONIA forward curves are projecting cuts to bank rate

Source: Bloomberg as of 11 May 2023. SONIA - Sterling overnight index average rate. Figure shows forward SONIA rates expected to be prevailing 1 year ahead.

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