LONDON — The Bank of England raised interest rates by 25 basis points on Thursday as it grapples with persistently high inflation amid concerns about the banking system.
The Monetary Policy Committee voted 7 to 2 to raise bank rates to 4.25%, a much-anticipated move after official data on Wednesday showed UK inflation unexpectedly rose to 10.4% year on year in February.
In its summary, the MPC stressed that global growth is expected to be stronger than forecast in February’s Monetary Policy Report, while core consumer price inflation – excluding volatile food and energy prices – has remained elevated.
The Bank of England estimates that the additional fiscal support announced last week in Chancellor of the Exchequer Jeremy Hunt’s spring budget will boost UK GDP levels by around 0.3% over the next few years.
GDP is likely to have been largely flat at the turn of the year, but is now expected to increase slightly in the second quarter, compared to the 0.4% drop expected in the February report,” the MPC said in its report.
“As the Government’s Energy Price Guarantee (EPG) is maintained at £2,500 for another three months from April, real disposable household income could remain broadly flat rather than falling significantly in the near term.”
The Bank stressed that much of the surprisingly strong basic commodity prices indicated in Wednesday’s inflation report can be attributed to clothing and footwear prices, which “tend to be volatile and may therefore prove less persistent.
Meanwhile, the labor market has remained tight, and the Bank now expects employment growth in the second quarter to be stronger than previously estimated, while the unemployment rate will be flat rather than rising.
Sterling climbed against the dollar shortly after the decision before splitting gains to trade about 0.2% higher.
UK banking system ‘remains resilient’
The US Federal Reserve also raised its key interest rate by 25 basis points on Wednesday, suggesting that “some additional policy tightening may be in order”. It acknowledged the likely impact of recent problems in the banking system.
The Swiss National Bank raised its own policy rate by 50 basis points to 1.5% on Thursday, while the European Central Bank raised it by 50 basis points last week amid banking sector turmoil.
Central banks around the world are following the fallout from the collapse of the US-based Silicon Valley Bank and the bailout of Credit Suisse.
Many analysts believe contagion risks have eased in recent days, and Thursday’s report said the Bank of England’s Financial Policy Committee found the UK banking system “remains resilient”.
The FPC assessed that the UK banking system “maintains robust capital and liquidity positions and is well placed to continue to support the economy across a wide range of economic scenarios, including a period of higher interest rates.”
“As a result of these developments, the funding costs of banks in the UK and other advanced economies have increased,” the MPC said in Thursday’s report.
“The MPC will continue to closely monitor any impact on credit conditions faced by households and businesses, and hence the impact on the macroeconomic and inflation outlook.”
‘Outside the herd’
Karen Ward, chief market strategist for EMEA at JPMorgan Asset Management, said the MPC was right to raise rates by 25 basis points.
“It is possible that recent concerns in the global banking sector will tighten credit conditions, but that is not guaranteed,” she said.
As with the ECB last week and the Fed last night, the Bank of England acted on the information it had today, namely that the economy is still resilient, inflation is uncomfortably high and broadening, and wage growth at a level inconsistent with a 2% inflation target.”
However, JPMAM is concerned that in the second half of 2023, the bank will be “outside the central bank herd”. The asset manager said inflation appears more persistent in the UK than elsewhere as the combination of Brexit, the pandemic and the energy crisis “appears to have done more lasting damage to the supply side of the economy.”
Goldman Sachs Asset Management, on the other hand, sees these risks diminishing and on Thursday called for a pause in interest rate hikes given the expected drag on growth from past monetary policy tightening and financial market volatility.
“Overall, the UK economy has faced a series of major supply shocks in recent years, including Brexit, the pandemic, the energy price shock and a decline in labor supply,” said Gurpreet Gill, global fixed income macro strategist at GSAM.
“These headwinds are easing to varying degrees and supply-side reforms included in the spring budget support the case for better outcomes on inflation going forward.”
Vivek Paul, UK chief strategist at BlackRock Investment Institute, said that, in addition to the actions of the Fed and ECB, the Bank of England’s decision to walk showed that the global economy is in a “new regime”.
“Central banks will not come to the rescue with interest rate cuts at the first signs of growth concerns, as we have been accustomed to for generations. (gilt yield spike) and monetary policy actions (dealing with inflation) are different,” he said.