Bank of England continues with a 50 bps rate hike
SummaryOn 22 September, the Bank of England (BoE) voted five to four to raise the U.K. base rate by 0.50% to 2.25%. The voting committee’s newest member, Swati Dhingra, voted for a lower 0.25% hike while the remaining dissenters voted for a higher 0.75%. While the hike matches the BoE’s largest ever hike, set in August’s meeting, it will be viewed as meagre against the backdrop of a more aggressive 0.75% hike from the Federal Reserve. The Federal Reserve rate increase was accompanied by dot plot illustrating that USD rates will go higher and stay there for longer than previously anticipated – a concerning scenario for the pound, with GBP-USD at 1.13, the weakest rate since the mid-1980s.
- The Bank of England raised the base rate by 0.50% to 2.25%.
- As of 12:30 BST, the 10-year GBP swap traded at 3.602%, 5-year at 4.090%, 2-year at 4.484%.
- The market is currently pricing in a further 100 bps of hikes across the final two MPC meetings of 2022.
- The vote was split five to four in favor of a 0.50% hike, with the dissenters split three and one for hikes of 0.75% and 0.25% respectively.
- The Bank of England will hold five gilt sale auctions in 2022, with a planned size of £580M per auction.
After market trader’s hedges against a 0.75% hike were unwound by 12:30 BST; the 2-year GBP swap rate regained ground to trade at 4.48% and 3 bps lower than its pre-announcement level. The 5-year GBP swap rate traded 3 bps above its pre-announcement level at 4.09%, and the 10-year GBP swap rate moved 9 bps above its pre-announcement level to trade at 3.60%. Sterling sold off ~500 pips to trade at ~1.1287 against the U.S. dollar by 12:30 BST. The upward move in swap rates past the belly of the yield curve suggests that the market does not have faith in the BoE’s ability to control medium to long-term inflationary pressures with its current policy stance.
Despite pre-meeting speculation that the BoE may delay the planned sales of gilts held in their Asset Purchase Facility (APF), in light of U.K. Prime Minister Liz Truss’ plans to issue new gilts in order to fund her energy price cap policy, the MPC voted to reduce the stock of gilts held in the APF by £80B over the next 12 months. This is in line with the strategy set out in the minutes of the August meeting. The Bank of England will hold five gilt sale auctions in 2022, with a planned size of £580M per auction. The gilt selling programme is expected to tighten monetary conditions further by applying upward pressure directly onto gilt yields.
Given imminent implementation of the energy cap, the BoE expects peak inflation to be lower than projected in the August report, at just under 11% in October. The minutes note that inflation is expected to remain above 10% over the following few months, before starting to fall back in 2023. Despite their belief that inflation should dissipate throughout 2023, the BoE continues to include wording allowing them to "respond forcibly” if the outlook suggests more persistent inflationary pressures than currently forecasted.
The BoE expects GDP to fall 0.10% in this quarter, compared with August’s forecast of 0.40% growth. Should the forecast materialise, the U.K. economy will have recorded two consecutive quarters of negative growth, the technical definition of a recession.
The three-way voting split in today’s base rate decision will not do any favors for the BoE’s increasingly fragile credibility. The U.K. is facing record high inflation, exacerbated by their excessive quantitative easing following the COVID-19 pandemic, and a pound that is at its weakest rate against the dollar for almost four decades. A lack of clear unison amongst MPC members in terms of future policy direction will compound fears, escalated this week after the Fed policy decision, that the UK is falling behind the curve in the fight against inflation.
On Friday, Kwasi Kwarteng, the U.K.’s Chancellor of Exchequer, is expected to deliver a “mini-budget” which will detail the funding and allocation of £150B of stimulus primarily aimed at supporting the energy cap. The BoE steered clear of commenting on the repercussions of deploying such stimulus in the prevailing inflationary environment, simply stating that it would assess the implications of the policy at its November meeting.
U.K. investors will now turn their focus to the U.K. August GDP data to be released in the second week of November. The BoE has two planned monetary policy meetings remaining in 2022, on 3 November and 15 December.
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