Bank of England Raises Interest Rates and Revises Economic Projections

Bank of England Raises Interest Rates and Revises Economic Projections

In a move to tame stubbornly high inflation, the Bank of England raised interest rates by 25 basis points. The Monetary Policy Committee voted in favor of the quarter-point increase, taking the main bank rate from 4.25% to 4.5%. The headline consumer price index rose by 10.1% in March, driven by high food and energy bills. Core inflation increased by 5.7% over the 12 months to March, unchanged from February’s annual climb. The MPC reiterated the risk of entrenchment that the bank is concerned about.

Economic Projections and Outlook

The Bank of England revised its economic projections, now excluding the possibility of a UK recession this year. The updated growth forecasts in its accompanying Monetary Policy Report show that UK GDP is now expected to be flat over the first half of this year, growing 0.9% by the middle of 2024 and 0.7% by mid-2025. The country’s newest GDP print will be published Friday. The economy has shown resilience in fending off a widely anticipated recession, with falling energy costs and a fiscal boost improving the outlook.

The MPC now assesses that “the path of demand is likely to be materially stronger than expected in the February Report, albeit still subdued by historical standards.” The MPC said in its May Monetary Policy Report that “risks remain but, absent a further shock, there is likely to be only a small impact on GDP from the tightening of credit conditions related to recent global banking sector developments.”

Inflation is expected to decline sharply from April as the large price hikes following Russia’s full-scale invasion of Ukraine drop out of the annual comparison. The extension of the government’s Energy Price Guarantee and further falls in wholesale energy prices also remove some inflationary pressure. However, the MPC projects that inflation will decline at a slower rate than previously projected in the February report, falling to 5.1% by the end of this year, compared with a previous estimate of 3.9%. It is still expected to drop “materially below the 2% target” to just above 1% at the two- and three-year time horizons.

The Bank of England struck a more hawkish tone compared to the US Federal Reserve’s hint of a pause in rate hikes last week. Vivek Paul, UK chief investment strategist at BlackRock Investment Institute, said that investor focus would not be on the 25 basis point hike but on what happens next. “We are in a new regime where central banks are faced with sharper trade-offs between maintaining growth and controlling inflation; in the Bank of England’s case, this is especially acute,” Paul said in an email.

Inflation since February’s forecasts has proven stickier than expected, and the Bank still forecasts a bleak growth picture for years to come, which will likely be exacerbated by higher-for-longer interest rates. There is also growing concern over labor market tightness and the risk of a wage-price spiral. Paul suggested that the Bank may be forced to keep rates higher for longer, a view echoed by Hussain Mehdi, macro and investment strategist at HSBC Asset Management. Mehdi said, “As rates move deeper into restrictive territory and credit conditions tighten, a policy-induced recession becomes almost inevitable.”

World

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