The first 75 bps hike from the Bank of England in 33-years in a split vote
SummaryOn 3 November, the Bank of England (BoE) voted seven-to-two to raise the U.K. base rate by 0.75% to 3.00%, the two dissenters voting instead for hikes of 0.25% and 0.50%. The BoE Governor, Andrew Bailey, voted for the 0.75% hike while pointing to a slowdown in the pace of future hikes. This move represents the BoE’s largest increase since 1989 and matches the recent hikes from the European Central Bank (ECB) and Federal Reserve. Bailey conceded that the Monetary Policy Committee (MPC) were “flying blind” following the U.K. government’s decision to move the budget announcement to 17 November, with the magnitude of future monetary decisions very much dependent on the government’s upcoming fiscal decisions.
- The Bank of England raised the base rate by 0.75% to 3.00%.
- As of 12:30 BST, the 10-year GBP swap traded at 3.78%, 5-year at 4.13%, 2-year at 4.40%.
- The market is currently pricing in a further 0.60% of hikes at the final MPC meeting of 2022.
- The vote was split seven-to-two in favor of a 0.75% increase, the two dissenters voting for 0.25% and 0.50%.
- The Bank of England has officially begun quantitative tightening, selling GBP 750M of gilts from its balance sheet at an auction on 1 November.
Ahead of the announcement the market had fully priced in a 0.50% rise, with the 0.75% 80% priced in. The market is now expecting that the daily SONIA rate will reach 3.38% by the end of year and will peak in September 2023 at 4.63%.
GBP swap rates fell at the short end of the curve following the announcement; the 2-year GBP swap rate was down 5 bps to 4.40%, the 5-year GBP swap rate was down 4 bps to 4.13%, and the 10-year GBP swap rate remained unchanged at 3.78%.
The meeting minutes emphasized the “very challenging outlook", with the BoE expecting U.K. GDP to decline by around 0.75% year-over-year during the second half of 2023 amid signs that labour demand is easing. Whilst the majority of the MPC still believes that further increases in the bank’s base rate will be required for a sustainable return to the 2% inflation target, the committee believes that the terminal rate priced into financial markets ahead of the meeting is too high. Despite minutes tilted more to the dovish side, the bank continued to stick to their “wait and see" approach with the reiteration of their language that if the “outlook suggests more persistent inflationary pressures, it will respond forcefully, as necessary”.
The MPC minutes note that they expect inflation to “fall back from early next year as previous increases in energy prices drop out of the annual comparison.” The bank expects that domestic inflationary pressures will remain strong in the coming quarters. The current forecasts are for CPI inflation to drop below the 2% target in two years, before falling further by 2025. In the post announcement press conference, Bailey commented, “inflation will begin to fall back from the middle of next year, and probably quite sharply.”
The BoE expects GDP to continue to fall across the next seven quarters up to Q2 2024. The meeting minutes detail “high energy prices and materially tighter financial conditions weighing on consumer spending" as the underlying driver behind the projections Although the data suggests that there is still a significant margin of excess demand within the U.K. economy, the BoE believes that continued weakness in spending will lead to an increase in the domestic unemployment rate in the first half of 2023. The bank expects the unemployment rate to rise to just under 6.5% by the end 2024. Earlier this week Ben Broadbent, the BoE Deputy Governor, noted August growth forecasts, which already pointed to a five-quarter recession, were based on a lower expected terminal rate of 3%.
The BoE’s quantitative tightening program commenced at the start of November, following delay due to the death of Her Majesty Queen Elizabeth and Liz Truss’ mini budget. The BoE sold GBP 750M of gilts ranging from 3- to 7-year maturities from their balance sheet at auction and was met with solid demand from investors. The bank had originally planned for a proportion of the sales to include gilts with maturities beyond 20-years, but were forced to reconsider in light of the sell down of gilts by pension funds. The BoE is targeting a net reduction (versus September 2022) of GBP 80B in its gilt holdings by September 2023, suggesting a future selling pace of around GBP 10B in gilts per month and so applying further upward pressure on short to medium term borrowing costs.
All eyes will now turn to the government’s fiscal statement on 17 November. Jeremy Hunt, the new Chancellor, is expected to lay out a plan to cut U.K. national debt by GBP 50B through a combination of tax rises and spending cuts. The next major U.K. economic data will be the September GDP released Friday, 11 November, where the consensus is for a quarter-over-quarter contraction of 0.1% with a year-over-year gain of 2.3%. The final BoE policy update for 2022 is scheduled for 15 December.
We expect rate volatility to remain high due to the continued uncertainty of the future rate path. The BoE’s admission that the current terminal rate may be too high could offer some temporary relief in GBP rate markets, providing an opportunity for borrowers to consider their interest rate hedging strategy in calmer market conditions.
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Transactions in over-the-counter derivatives (or “swaps”) have significant risks, including, but not limited to, substantial risk of loss. You should consult your own business, legal, tax and accounting advisers with respect to proposed swap transaction and you should refrain from entering into any swap transaction unless you have fully understood the terms and risks of the transaction, including the extent of your potential risk of loss. This material has been prepared by a sales or trading employee or agent of Chatham Hedging Advisors and could be deemed a solicitation for entering into a derivatives transaction. This material is not a research report prepared by Chatham Hedging Advisors. If you are not an experienced user of the derivatives markets, capable of making independent trading decisions, then you should not rely solely on this communication in making trading decisions. All rights reserved.22-0287
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