BoE to decide biggest rate hike in 27 years

On Thursday, the Bank of England is broadly expected to hike interest rates by 50 basis points, its largest single increase since 1995. This move would take borrowing costs to 1.75% as the central bank encounters rising inflation and would be the first half-point hike since it was made independent from the British government in 1997.

UK inflation hit a new 40-year high of 9.4% in June as food and energy prices continued to surge, deepening the country’s historic cost-of-living crisis. BoE’s Governor Andrew Bailey suggested on July 19 that policymakers could consider a 50 basis point hike, vowing that there would be “no ifs or buts” in the Bank’s commitment to returning inflation to its 2% target. A Reuters poll taken over the past week indicated that over 70% of market participants now anticipate a half-point rise.

Although the economic data since June’s 25 basis point hike had not moved the needle significantly, the policymakers’ prior commitment to act “forcefully” to bring inflation down, and the market more-or-less pricing in 50 basis points at this stage, means policymakers are likely to err on the aggressive side.

Key points to watch out for in Thursday’s report would be whether the BoE continues to use the word “forcefully,” and its forecasts, which plug market expectations into the Bank’s models and expected policy trajectory.

Slowdown-linked Worries
A more aggressive approach at Thursday’s meeting would bring the Bank’s monetary tightening trajectory closer to the trend set by the U.S. Federal Reserve and the European Central Bank, which implemented 75 and 50 basis point hikes last month, respectively.

But while it may fortify the Bank’s inflation-fighting credibility, the faster pace of tightening will exacerbate downside risks to the already-slowing economy.

Governor Bailey will likely carry a majority of the nine-member MPC if he backs a 50 basis point hike on Thursday, and projected that with inflation likely still rising¸ the Bank will hike by another 50bp in September.

Energy prices
Britain’s energy regulator Ofgem increased the energy price cap by 54% from April to accommodate soaring global costs, but is expected to rise by a greater degree in October, with annual household energy bills predicted to surpass £3,600 ($4,396).

In particular, surging energy prices are feeding into our forecast of the Ofgem price cap and will force the BoE to revise up its inflation forecast yet again. Higher inflation for even longer is the kind of scenario that spooks central banks because of higher risks of persistence and spillovers.