Will BoE Hike Interest Rates To Pre-Covid Level?

On Thursday, March 17 at 12:00 GMT, the Bank of England will announce its decision and as markets get closer to the release time, the British central bank is widely expected to raise the benchmark interest rate by 25 bps from 0.50% to 0.75%, marking a lift-off for a third consecutive meeting, amid Ukraine crisis-led uncertainty, growth concerns and raging inflation.

Practically, major central bank, In general, encounter a real dilemma amid hot inflation and weak outlook for economic growth. The biggest concern among MPC members is that higher inflation will become an entrenched feature of the UK economy, with prices and wage demands rising.

Therefore, the Bank of England could hike interest rates to their pre-Covid level this week, but caution exists that such a decision could push back against financial markets’ expectations that borrowing costs will continue to climb over the year ahead.

The renewed surge in energy prices since Russia’s invasion of Ukraine has cemented the case for the BoE Monetary Policy Committee to raise interest rates for the third time since December owing to soaring inflation.

Most forecasters predict the MPC members will on Thursday support a quarter-point increase, from 0.5 per cent to 0.75 per cent, taking the benchmark rate back to the level it stood at in January 2020.

Such a decision is not expected to prevent inflation scaling new highs in the short term and staying high for longer. According to Goldman Sachs, inflation will reach 9.5 per cent in October 2022, when the energy price cap is due to rise again.

Consumer price inflation rose to an annual rate of 5.5 per cent in January: its highest level in 30 years.

If businesses and households come and see inflation as normal and raise their prices and wage demands accordingly, the risk of persistently higher inflation therefore makes it likely the BoE will want to act decisively now.

The UK economy rebounded rapidly from the slowdown induced by the Omicron variant of coronavirus, with gross domestic product increasing by 0.8 per cent in January compared with the previous month. Official data released on Tuesday are likely to show that workers are well-placed to press for higher wages in a booming labour market.

But the new energy shock puts the policymakers in a difficult dilemma, because it will deal a painful blow to household incomes and business sentiment, compounding the BoE’s weak outlook for economic growth in the medium term.

Markets are betting that concerns over inflation will dominate the policymakers’ discussions on tightening the British monetary policy that would take the benchmark rate to 1.5 per cent by late summer and 2 per cent after a year from now: a level it has not reached since the global financial crisis.

Inflation should stabilize rather than spin out of control. There exist grounds for BoE’s policymakers to raise interest rates in May to 1 per cent, but the case for going further was slim at best, with the economy set to stall in the final quarter of 2022, and even more intense downside risks to growth in 2023.

Interest rates could rise again by 25bp in May, but that increases beyond that would be highly data-dependent given the significant uncertainty around energy prices and their negative impact on real incomes and demand.

MPC are expected to hike Bank Rate by 25bps and signal further tightening, but with a cautious tone. A single further hike is expected this year, in May. A shifting UK macro mix of growth and inflation leaves GBP vulnerable, especially given the extent of BoE hikes priced into the curve.

Some views suggest that BoE seems stuck between a rock and a hard place. Stagflation risks are very real. Tighter monetary policy will create more impact on growth and fail to accommodate hot inflation. The recent surge in the price of imports makes it almost certain that inflation heads higher than the projected peak of 7.25%; even a double-digit rate of inflation can’t be ruled out.

The passthrough from the real income squeeze to real spending should become increasingly visible over the course of 2022. We have added three more 25 bps hikes to 1.50% to our forecasts (May, June, August). If economic growth does indeed stagnate, these could very well be a prelude to cuts in 2023.