Bank of England see-saw back to a dovish stance

In Brief

The Bank of England (BoE) raised the Bank Rate by 25 basis points (bps) to 0.75% in a split 8-1 vote with the dissenting Monetary Policy Committee (MPC) member calling for no change on 17 March 2022.
Concerns about the tight labour market and greater persistence of domestic inflation justified the rate hike from the BoE. While further rises may be warranted, two-way risks remain as war continues in Ukraine and higher commodity prices squeeze real household incomes.
The increase in Bank Rate will bring further respite from ultra-low yields for cash investors, however with interest rate volatility likely to continue, maintaining a disciplined approach to cash segmentation remains key.

The Bank of England (BoE) used the opening statement of the March MPC meeting minutes to condemn Russia’s unprovoked invasion and the suffering inflicted on Ukraine and said it is working closely with the UK government to support its response in coordination with international authorities.

The BoE policy decision, meanwhile, delivered on market expectations on the one hand – by increasing the Bank Rate by 25 bps to 0.75% (Figure 1) – while on the other, the dissenting voice of Jon Cunliffe was a dovish surprise with a vote to maintain Bank Rate at 0.50%. This was especially surprising considering the hawkish dissent at the February meeting when four committee members called at that point for an immediate increase to 0.75%. Even as interest rates get back to pre-pandemic levels (Figure 1), the market volatility and uncertainty around the future path of rates could have significant implications for interest rates, yields curves and cash investors.

A soft landing is not guaranteed!

As the final restrictions related to the Covid pandemic lifted in the UK, business confidence remained resilient and growth was higher than expected in January. Combined with a fall in unemployment to 3.9% in the three months to January; higher wages; and rising inflation expectations; the MPC decided that conditions warranted a third consecutive hike in Bank Rate – the first time it has done so since 1997, shortly after the BoE gained operational independence from the government.

Growth momentum is still expected to ease over the medium-term as energy price increases bite and looser financial conditions fade. Annual consumer price index (CPI) inflation rose to 5.5% in January and is now expected to peak over 8% in the second quarter of this year. Continued conflict in Ukraine could also prolong and augment upward pressure on commodity prices. Alongside continued global supply chain disruption, such imported inflation could weigh further on household spending and consumer confidence, so a soft landing for the economy is certainly not guaranteed.

Shocks and disturbances

The MPC was clear that external “shocks and disturbances” can cause inflation to depart from the 2% CPI target and this is not something monetary policy can prevent. The key to its mandate is meeting the target over the medium-term “in a way that helps to sustain growth and employment”. While the BoE indicated that further tightening ‘may’ or ‘might’ be appropriate in coming months, this was caveated by the risks to both sides depending on the medium-term outlook. Passive quantitative tightening has also started with the maturity of the March 2022 gilt (Figure 2) held by the Asset Purchasing Facility (APF) and the stock of total assets held now stands at £867 billion. From here on, the evolution of economic data and geopolitical events will be closely monitored, yet it will be the persistence of cost pressures that will be the key determinant in the timing and magnitude of future hikes, and ultimately where the terminal rate will land.

Investors Implications

Sterling cash investors should welcome this further increase in Bank Rate as improved overnight rates and steeper curves could allow liquidity and ultra-short duration strategies to boost yields – albeit with a slight delay due to the need to reinvestment maturities.

However, the trade-off between inflation and growth, and uncertainty regarding a resolution to the conflict in Ukraine, suggests bond yield and curve volatility could remain high. Elevated market volatility could increase the risk of capital losses on longer duration strategies. We believe investors should therefore maintain a disciplined approach to cash segmentation by prioritising a combination of money market and ultra-short duration strategies. In this way, sterling investors can aim to optimise returns without excessively increasing risk or volatility.

Unless otherwise stated, all data sources are from BoE’s MPC meeting dated 17 March 2022.

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