The Bank of England (BoE) raised Bank Rate by 50 basis points (bps) to 5.00% as recent upside in data indicated more persistent inflationary pressures and justified a 13th consecutive increase.
Broad-based, higher-than-expected inflation and resilient growth, fuelled by a tight labour market and pickup in wage growth, prompted the BoE to hike interest rates by 50bps – somewhat against market expectations of 25bps.
Given that the potential lagged effects of previous monetary policy tightening have yet to feed through, the BoE confirmed the future path of rates will be data dependent.
A 50 bps hike to a new high
At its June 2023 meeting, the Monetary Policy Committee (MPC) raised Bank Rate to 5.00%, a new 15-year high (Exhibit 1). The 50bps increase was larger than expected by the market as the BoE faces two challenges: consumer price index (CPI) inflation, which remained stubbornly elevated at 8.7% year on year (YoY) in April 2023, and a persistently tight labour market. Seven MPC members voted in favour of the immediate increase to combat the second-round effects in domestic price and wage developments that are taking some time to unwind. Two members – Swati Dhingra and Silvana Tenreyro – preferred to keep the Bank Rate unchanged, citing that lagged effects from past rate increases are yet to feed through and the expected energy price shock reversals this year should reduce goods price inflation and, in turn, persistent domestic price pressures. This was Tenreyro’s last meeting, and she is replaced by Megan Greene who will join the MPC on 5 July 2023.
Exhibit 1: UK Bank Rate is at 5.00% for the first time since October 2008
Strength in numbers
While the market was somewhat surprised by the size of the June rate hike, a further increase was warranted given the recent upside surprise in UK economic data. Monthly GDP increased to 0.2% in April – close to pre-pandemic levels – while surveys suggest quarterly growth will hit 0.25% in Q2 2023. Labour market tightness – unemployment has fallen to 3.8% – and a decrease in the inactivity rate has kept upward pressure on wages. The annual increase in private sector wages, which is a key indicator for the BoE, was 7.6% in the three months to April. However, indications of future pay growth show some expected moderation over the rest of the year. The pressure from rising mortgage repayments curbing household spending, alongside falling energy prices, weakness in global goods prices and a 6% appreciation in the sterling effective exchange rate since the beginning of 2023, should combine to lower CPI significantly throughout the rest of the year.
Yet upside risks remain. Terminal rate expectations have increased since the May Monetary Policy Report was published, and while the market expects the BoE to reach the end of its current rate hiking cycle by the end of the year (Exhibit 2) further evidence of persistent price pressures could change these assumptions. Volatility remains elevated and the path for interest rates may continue to be unpredictable as economic slack emerges in the global economy.
Exhibit 2: Terminal rate expectations have increased since the BoE’s 11th May meeting
Sterling cash investors should welcome this further increase in Bank Rate as improved overnight rates will further boost returns for liquidity strategies, albeit with a slight delay due to the need to reinvest term maturities. Ultra-short-term cash strategies are also well positioned to capture the uplift in overnight rates. 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.