Bank of England interest rate decision too close to call

·5-min read
Governor of the Bank of England Andrew Bailey
Governor of the Bank of England Andrew Bailey. Photo: Hannah McKay/Reuters

Andrew Bailey and the Bank of England's (BoE) monetary policy committee (MPC) have an interest rate dilemma on their hands. 

With much chatter in the market, due to a better than expected economic recovery from COVID, many have pencilled a rate increase from record lows of 0.1%, for the meeting on 4 November.

The decision comes amid a mixed economic picture in the UK. The Office for Budget Responsibility (OBR) expects UK GDP to grow by more than 6% in each of 2021 and 2022 and currently forecasts inflation to run at 4% in 2022, well above the BoE's target. 

Inflation has climbed since the spring above the BoE’s target level of 2% to 3.1%.

Unemployment is below 5%, wage growth is picking up, house prices are rising sharply and asset prices generally are surging, as evidenced by London’s FTSE indices and global benchmarks.

Bailey's recent quip that the bank “will have to act and must do so if we see a risk, particularly to medium-term inflation” has led to some doubling down on bets of a faster rise in rates. 

But what the bank will decide is still uncertain for many reasons. 

Watch: What is inflation and why is it important?

Read more: Bank of England chief economist keeps November interest rate hike possibility 'live'

Policy has varied around the world as central bankers grapple with an uncertain environment. The Reserve Bank of Australia’s (RBA) decision to scrap one of its three key tools — removing yield curve control — and start tightening monetary policy may be making bankers elsewhere nervous. 

The RBA said on Tuesday it would no longer try to cap the three-year bonds at 0.1% as volatility reigned in short-term bond markets.

Elsewhere, there have been a rash of rate rises around the globe and moves to taper or even halt Quantitative Easing, with New Zealand, Canada and others shifting positions. 

"These all beg the question of whether the American and British monetary authorities are in danger letting policy run too loose for too long – although some would argue the damage is already done on that front," said AJ Bell investment director Russ Mould. 

Over the past 12 months the yield on the benchmark US 10-year Treasury has increased from 0.86% to 1.57% and the yield on the UK 10-year Gilt has gone from 0.26% to 1.06% — figures that are below the prevailing rates of inflation in the US and UK. 

"Both countries 2% inflation target, so bond markets are still giving policy makers the benefit of the doubt – although you could argue that Quantitative Easing programmes and massive Fed and Bank of England bond holdings give them little choice as central banks seek to bend bond markets to their will," says Mould. 

Any increase in rates now would be the BoE's first since summer 2007.

Watch: Will Interest rates stay low forever?

Analysts at Deutsche Bank are betting for a 25 bps bump at this meeting. They also expect the MPC to end its current QE program – one month earlier than expected, trimming £20bn from its QE envelope.

Rate hikes, DB says, would allow the MPC to begin quantitative tightening (QT) as soon as Q2-2022 (i.e. following their Feb rate hike). 

"As pandemic support is reversed, we expect the BoE to pause, with perhaps one more rate hike in the pipeline taking the Bank Rate up to 1% by Feb-23," senior economist Sanjay Raja and strategist Panos Giannopoulos wrote. 

Other analysts are betting the BoE will stick this time. "At 63% probability, this is still a close call," said Thomas Pugh, economist for RSM UK. "We expect the vote to be 5v4 in favour of leaving interest rates at 0.1%. 

"This might imply a glass half-empty/half-full policy of keeping the BoE rate at near-zero for another MPC meeting, or two, with forward guidance preparing the markets for a rate hike in December or early 2022."

Reasons given for this include the upward pressure on money market rates caused by policy concerns, plus the threats of near-term price increases and long-term wage increases, the degree of accommodation built into UK financial asset markets has drifted ever so slightly lower in recent trading. 

"Money market spreads widened just a bit, while the yield-curve spread between 10-year government bonds and 3-month T-bills flattened, reflecting concerns for long-term growth if the BoE was to lightly touch the brakes," said Pugh. 

Read more: Markets tread water ahead of Fed bond tapering announcement

Some believe that the bank should wait for the dust to settle from the fallout of the pandemic before making any rash moves. After all, the furlough scheme has only just ended and pressure on supply chains has raised a warning alarm in many consumer price indexes. 

With inflation in sight, however, there's a chance action will come sooner rather than later. 

“Perhaps the question now is when will the pendulum swing again, prompting the Bank of England, US Federal Reserve and others to start tapering QE and raising interest rates with vigour," said Mould. 

"The answer, for now, seems to be ‘not yet,’ but perhaps tighter policy in Canada, New Zealand, Australia and others is the first sign of a subtle change in thinking.”

Watch: What is inflation and why is it important?

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