Bailey enacts biggest rate rise since 1995

Pressure on the BoE to act meaningfully in the fight against inflation was high coming into this MPC meeting after 0.75% and 0.50% base rate increases from the Federal Reserve and ECB, respectively, at their most recent meetings. The BoE now expects inflation to hit 13% by the end of the year and remain at “very elevated levels throughout 2023”, aided by increases in energy prices.

The longevity of the rate hiking cycle will be challenged by the worst economic growth outlook since the Great Financial Crisis. The BoE now forecasts that the U.K. will fall into a recession in Q4 this year and remain as such until Q1 2024. The U.K. gilt curve inverted between the 2- and 10-year maturities, a prominent sign of oncoming recession, for the first time since 2019 immediately following the announcement. Despite the looming headwinds, the meeting minutes highlighted that U.K. labour market demand had “remained strong” with vacancies remaining close to their record high in the three months to June.

The BoE also shed more light on how the central bank’s quantitative tightening (QT) programme would work, the first of its kind in a major economy. Active gilt selling is likely to start in September – following a largely processional confirmation vote – and the MPC has set a target pace of GBP 10B per quarter. When added to the current tapering programme, that brings up a total APF reduction of GBP 80B over the next 12 months. The BoE will also launch a new Short-Term Repo facility, aiming to keep short-term market rates close to the set base rate throughout the balance sheet reduction process. They will manage this objective by allowing counterparties in the interbank market to borrow unlimited amounts of reserves for 7 days. This will ensure that banks can meet their minimum deposit threshold without needing to source reserves outside of the facility at higher rates. The BoE added that there would be a “high bar” to altering the plan as they look to unwind the asset mountain acquired throughout the COVID-19 pandemic. Alongside gilts, the APF will also sell their relatively small holding of high-grade corporate bonds. The QT mechanism represents a powerful new tool to fight inflation and will help the BoE fend off critics who believe that despite being the first major central bank to raise rates, the BoE has been far too timid and systematic in its continued 0.25% base rate hikes. It is notable that the BoE has just become the 71^st central bank globally to raise rates by 0.50% or more in 2022.

Suella Braverman, the U.K. attorney general and ally of Tory leadership favorite Liz Truss, has suggested that Truss would examine the BoE’s “exclusionary independence on interest rates” should she become Prime Minister. Braverman retrospectively criticized the speed of reaction from the BoE when inflation began to emerge in Q3 2021 and added that Truss had made it clear to her that she “wants to review the mandate that the Bank of England has and see whether it’s fit for purpose”.

U.K. investors will now turn their focus to the UK GDP data to be released next Friday. Barring any emergency meetings, the next MPC meeting will be held on September 15, with the final meetings of 2022 to be held in November and December.