BoE hikes 25 bps and warns more to come, while ECB cools on a September hike
Summary
The Bank of England (BoE) raised borrowing costs by 25 basis points at their meeting today, a smaller hike than their June meeting following better-than-expected data. However, two policymakers voted for a 50-basis-point increase. The BoE's statement warned that some of the upside inflation risks "have begun to crystallise," specifically around wage growth.
The European Central Bank (ECB) also raised rates at their meeting last week, increasing by 25 basis points, taking its deposit rate to 3.75% — the highest level since the turn of the millennium. The central bank repeated that inflation was expected to remain "too high for too long," suggesting that they may still have to raise rates. However, there was a subtle but deliberate change in the statement that indicates the Governing Council could keep rates on hold in September, as recession risks grow and inflation starts to ease.
Bank of England
The BoE's 14th consecutive rate hike took borrowing costs to 5.25%, a 15-year high as it continues to battle the highest inflation rates of the G7 economies. In the statement, the Monetary Policy Committee (MPC) warned that borrowing costs may have to stay high, with updated forecasts showing inflation not returning to target for almost two years. The statement said, "The MPC will ensure that bank rate is sufficiently restrictive for sufficiently long to return inflation to the 2% target," suggesting there is little prospect of rate cuts over the next couple of years. BoE Governor Andrew Bailey also highlighted that the pace of wage growth was “materially above” the Bank's previous forecast, with inflation likely to come down slower. Forecasts were based on the market implied path for a peak rate of 5.75%, suggesting a September hike is remaining.
Following data last month that showed wages, excluding bonuses, rising to the highest record since 2001, markets were pricing 50-basis-point rate hikes at today’s meeting and the September one, with a peak rate of 6.50% early next year. However, the latest reading on inflation for June showed a larger-than-expected fall in the headline rate, while the core rate unexpectedly slowed. Heading into today’s meeting, markets were leaning towards a 25-basis-point increase, with encouraging inflation reports from the U.S. and the Eurozone adding to optimism that the worst of the price pressures are behind us.
With the prospect of a lower peak but prolonged period of higher rates, there was a small dip in two-year swap rates, while five-year rates remain unchanged.
European Central Bank
With President Christine Lagarde hinting at a quarter-point rise in July and stating the Bank's intention to bring rates to a level “sufficiently restrictive to achieve a timely return of inflation to our 2.00% medium term target" at the previous meeting, the ECB’s decision to raise rates was widely expected.
Since their June meeting, business surveys have shown a further deterioration in activity growth for July — economic sentiment has continued to worsen, and Eurozone banks have reported a sharp fall in demand for business loans to the lowest level on record.
In raising rates for a ninth consecutive time last week, President Lagarde suggested they may have reached a sufficiently restrictive level to bring inflation back to target saying, "Do we have more ground to cover? At this point in time, I wouldn't say so.” Lagarde refrained from providing explicit forward guidance for a hike at their next meeting stating, “It’s a decisive maybe.”
Two-year and five-year swap rates both fell by ~10 basis points, as the market interpreted the comments as slightly more dovish than expected.
Moving forward
The U.K. economy has fared much better than forecast so far this year, but the risk of recession grows with every increase in borrowing costs. For now, the BoE has little choice but to stay the course until it sees clearer evidence that inflation is slowing and will continue sustainably towards its 2.00% target.
The case for a further ECB rate hike remains, but the bar appears to have been set quite high with recession risks starting to become more a concern. Markets are almost split 50/50 on the ECB pausing next month and not hiking again, even if President Lagarde has said such a move would not be “definitive.”
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