The statement added that although global GDP growth expectations for 2023 remain weak and energy prices have materially declined, inflationary pressures remain high across most developed economies, supporting the decision to continue to tighten monetary conditions. Additionally, the MPC reiterated that UK GDP growth is expected to remain flat in 2023, representing an improvement from the mild recession anticipated earlier in the year. However, BoE staff estimate that the recent measures announced by UK Chancellor Jeremy Hunt in the Spring Budget will provide a boost of only 0.3% to UK GDP over the coming years.
Investment Insights • MFN
3 min read
Bank of England hikes rates to deal with persistent inflation
Bank of England At its latest Monetary Policy Committee (MPC) meeting, the Bank of England (BoE) raised interest rates by 25 basis points to 4.25%, as anticipated by markets. This represents a reduction in the pace of tightening of monetary policy, after two consecutive 50bps hikes, and the 11th hike since December 2021. In the statement issued after the meeting, the MPC reaffirmed the stability of the UK banking system and reiterated its commitment to bringing inflation down to the 2% target.
Chart 1. UK Bank Rate and future market expectations (%)
Source: Refinitiv, Bloomberg and EFGAM. Data as of 23 March 2023. For illustration purposes only, not advice.
The interest rate increase reflects the BoE’s commitment to control inflation despite recent turmoil in the global banking sector and comes days after February inflation surprised to the upside. The latest data show the CPI increased by 10.4% year-on-year, accelerating from 10.1% in January.
The pick-up in February headline inflation was mostly due to prices of food and non-alcoholic drinks, which increased by 1.5% month-on-month. This rise in food prices was related to extreme weather conditions leading to some shortages in UK supermarkets but is expected to be a transitory phenomenon. However, core inflation, which excludes food, energy, alcohol, and tobacco, was up 6.2% yoy, after a 5.8% increase in January. Domestic price pressures in the services sector were the main driver of core prices, influenced by UK wage growth which is close to 7% annualised.
In the future inflation is expected to decline reflecting falling energy prices and the softening in economic activity caused by the cumulative 415bps of monetary tightening since December 2021. Furthermore, two external factors will also contribute to moderate inflation.
The first factor is the situation in the banking sector. Concerns over the stability of the banks is likely to lead to a more cautious approach to lending, contributing to a reduction in final demand.
The second factor is the recent progress made by the UK government on wage negotiations. Discussions with unions representing healthcare and rail workers are close to ending months of pay disputes. The anchoring of inflation expectations and salary settlements will contribute to the stabilization of wage growth, which according to the MPC will fall faster than previously expected in 2023.
Following the March meeting, the MPC has indicated that it may hike by another 25bps in May if there is clear evidence of persistent inflationary pressures. Market expectations have corrected in the last few months, with only one more rate increase expected by the BoE in May, before pausing. According to our models, UK headline inflation will converge towards the 2% target in the coming months, so one more rate increase before a pause in the summer seems reasonable (see Chart 1).
Problems in the UK economy with low productivity, the low participation rate in the labour market and the implementation of the new trade arrangements between the UK and the EU remain key headwinds for growth in the coming years. Therefore, the BoE will have a narrow margin of error as further tightening will risk pushing the economy into recession.