In Brief

• The Bank of England (BoE) raised the Bank Rate by 25 basis points (bps) to 4.25% in a split 7-2 vote as indications of persistent inflationary pressures – including a continued tight labour market, predicted near-term strength in growth, and cost and price pressures – justified an 11^th consecutive increase.
  
  
• UK consumer price index (CPI) inflation rose unexpectedly in February; however, the BoE predicts a significant fall in coming months due to an extension of the energy price cap as well as expected wage growth moderation.
  
  
• The outlook for the economy remains highly uncertain and the BoE’s conditional guidance on the future path of interest rates remains data dependent.
  

Another split decision

At its March 2023 meeting, the Monetary Policy Committee (MPC) raised the Bank Rate by 25bps to 4.25%, the highest level since November 2008 (Exhibit 1). The increase was largely expected by the market despite recent global financial market volatility. Seven MPC members voted in favour of the immediate increase as inflation bounced higher and growth remained resilient. Two members – Dhingra and Tenreyro – dissented with a vote for rates to remain unchanged, suggesting base rates were already sufficiently restrictive.

In the accompanying statement, the MPC repeated previous conditional guidance that it will “continue to monitor closely indications of persistent inflationary pressures”, including labour market conditions alongside wage and services inflation to determine if “further tightening in monetary policy would be required”.

Exhibit 1: The UK Bank Rate is at 4.25% for first time in nearly 15 years

Source: Bank of England; data as at 23 March 2023.

Inflation rises but is expected to fall again

Headline inflation had been falling from a peak of 11.1% in October 2022 to 10.1% in January 2023 but a bounce back to 10.4% in February 2023 – as food and core goods inflation strengthened – was a cause for the BoE to raise rates immediately. The BoE’s forecasts do continue to predict that inflation will fall significantly in the second quarter as government support for households through the extended Energy Price Guarantee, and lower base effects combine with expected lower wage growth to ease domestic UK price pressures.

However, services inflation is expected to remain sticky, and alongside the predicted boost in GDP from the fiscal support announced in the Spring Budget, and data pointing towards stronger-than-expected employment growth, risks do remain to this downward predicted path.

Evolution of the economy remains key

With recent market volatility focusing attention on the global banking sector, the BoE’s Financial Policy Committee judged that the UK banking system remains resilient and can support the economy through a range of scenarios. With the Bank Rate having risen significantly since the start of this hiking cycle, the lagged effects may not yet be fully felt by households and businesses, and as funding costs for banks rise, any further tightening of financial conditions could increase uncertainties around the financial and economic outlook. Therefore, the MPC will need to continue to monitor these risks and the inflation outlook closely, leaving the future path of interest rates highly data dependent.

Investor implications

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 is nearing the end of its current rate hiking cycle and may even start to cut rates later this year (Exhibit 2). However, the path for interest rates remains unpredictable.

Against this uncertain backdrop, a cautious and disciplined investment approach to cash segmentation may be most appropriate for sterling cash investors, prioritising a combination of money market and ultra-short duration strategies. Such an approach should ensure investors continue to optimise returns without excessively increasing risk or volatility.

Exhibit 2: UK SONIA forward curves are projecting cuts to the Bank Rate

Source: Bloomberg; data as at 23 March 2023. SONIA stands for sterling overnight index average rate. This exhibit shows forward SONIA rates expected to be prevailing one year ahead.

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