BoE slows the pace of hikes with rates rising to 5.25%
- The Bank of England (BoE) opted to raise Bank Rate by 25 basis points (bps) to 5.25%, as a recent cooling in both inflation and the economic outlook allowed it to moderate the magnitude of its hike from the 50bps delivered in June.
- Markets had been pricing in some chance of another 50bps hike at this meeting which, had it happened, could have raised the possibility of further 50bps hikes. However, the 25bps increase gives us greater conviction that we won’t see any more 50bps hikes in this cycle.
- Given that services inflation and wage growth remain elevated, we expect the BoE will raise rates by 25bps again at the next meeting but are increasingly confident that we are approaching a peak in rates.
A 25bps hike rather than 50bps
At its August 2023 meeting, the Monetary Policy Committee (MPC) raised Bank Rate to 5.25%, a new 15-year high (Exhibit 1). The latest inflation print for June had seen headline CPI (Consumer Price Index) decline to 7.9% year on year, still very high but down from 8.7% in May and a peak of 11.1% in October last year. The growth outlook has also deteriorated, with the Committee noting that a greater number of the Bank’s Agents had reported a slowing in the outlook for activity.
Six MPC members voted in favour of the 25bps increase, judging that although the monetary stance was weighing on economic activity, a 25bps increase was still necessary to address the risks from greater inflation persistence. Two members – Jonathan Haskel and Catherine Mann – voted to raise rates by 50bps, concerned by a still tight labour market and strong pay growth. Swati Dhingra continued to vote against an increase in rates, citing the lagged effects from past rate increases that are yet to fully feed through, and suggesting that the risks of overtightening are building. Silvana Tenreyro, who last meeting joined Dhingra in voting against a hike, was replaced by Megan Greene who voted with the majority in favour of the 25bp hike.
Strong service inflation vs weaker growth outlook
Annual private sector regular pay growth increased to 7.7% in the three months to May, and three-month on three-month growth in this measure picked up further. Wage growth is expected to remain strong in the near term, with the risk that there could be further upside surprises, according to the Committee. Strong wage growth is a primary reason behind elevated services inflation.
However, developments in some forward-looking indicators, such as the KPMG/REC UK Report on Jobs, implied that wage growth could slow more sharply than anticipated in the second half of 2023.
The UK composite PMI business survey also indicated a slowdown in activity and past increases in Bank Rate are expected to increasingly weigh on UK activity and inflation in the coming quarters. Relative to the May projection, quarterly GDP growth is expected to be weaker throughout much of the forecast period, particularly during 2024 and at the beginning of 2025.
An increasing degree of economic slack is expected to emerge after the middle of next year and the unemployment rate is projected to rise by somewhat more in the Committee’s latest projections than in the May Report, reflecting the weaker forecast path of GDP.
Liquidity strategies continue to benefit from the move higher in rates, with the potential for further rate increases in the near term. Ultra-short-term cash strategies will look to take advantage of increased conviction that we are getting closer to the peak in rates to moderately lengthen duration from the very low levels we have been running as rates moved aggressively higher over the past couple of years.