BoE is torn between fighting inflation and recession danger

The Bank of England, which is expected to increase interest rates once again on Thursday, must balance the need to combat an inflation rate that is already running at more than four times its objective against the harm that 13 consecutive rate increases have already done to the economy.

Most analysts and investors anticipate that the Bank Rate will rise by a quarter point, reaching a 15-year high of 5.25%. They will also be keeping an eye out for any indications the BoE gives regarding potential future rises.

The economic effects of the rate increases that have been implemented since late 2021, according to Governor Andrew Bailey and his colleagues, have not yet been fully felt. But they also assert that they must stop the greatest inflation rate among major economies.

British consumer price inflation decreased significantly from 8.7% in May to 7.9% in yearly terms in June, a greater decrease than was anticipated. But among the economies of the Group of Seven, it remained the highest.

Core inflation, which includes prices for energy, food, alcohol, and tobacco as well as price hikes in the services sector, also decreased but stayed near to the 31-year highs it reached in May. Core inflation is a gauge of underlying price growth.

The housing market has been the biggest direct beneficiary of the BoE’s hike in the Bank Rate from 0.1% in December 2021 to the present 5.0%.

Given the rapid rise in mortgage interest rates and the prospect of further increases in borrowing costs, house prices as measured by mortgage lenders Nationwide and Halifax have dropped by their highest in yearly terms in more than a decade.

Because the majority of mortgages in Britain are short-term fixed-rate agreements that shield homeowners from changes in borrowing costs but are renewing at higher rates, the BoE claims that much of the impact on the housing market from its rate hikes has yet to be felt.

Around 800,000 of the approximately 7 million fixed-rate mortgages, or 80% of residential house loan transactions, expire in the second half of 2023, while another 1.6 million do so in 2024.

To maintain and attract employees, many businesses are still hiring and raising pay significantly, which is a major concern for the BoE in its fight against inflation.

In records going back to 2001, data for the three months ending in May revealed that wages excluding bonuses climbed by a joint-highest amount.

Nevertheless, there are indications that the labour market is slowing down. In the month of March through May, the unemployment rate unexpectedly increased to 4%, while the number of openings decreased for the 12th straight month to their lowest level since mid-2021.

Despite the compression on their salaries caused by inflation, the majority of consumers have been able to maintain their spending pace.

Despite being 1.0% lower than in May of last year, retail sales volumes unexpectedly increased from May to June.

A lot of folks still have some of their pandemic-related money. The saving ratio, which measures household savings as a percentage of disposable income and includes employer pension contributions, was 8.7% in early 2023, down from 9.3% in late 2022 but higher than 5.6% just before the pandemic struck.

GfK’s index of consumer confidence declined in July after reaching a 17-month high in June. It is still below where it was for the most of the last ten years. Household debt levels are lower than they were prior to the global financial crisis of 2007–2009.

We believe the outsized move in Jun will be a one off. The recent slew of economic data should ease some of the pressure to keep on raising interest rates sharply.

We keep to our view that the BOE will likely hike by 25bps at each of its next two meetings (3 Aug and 21 Sep), culminating with a terminal rate of 5.50%. 

UOB