The Bank of England has set interest rates for the biggest rise in 33 years, but economists expect a cut

The Bank of England has set interest rates for the biggest rise in 33 years, but economists expect a cut

The Bank of England has set interest rates for the biggest rise in 33 years, but economists expect a cut

Buses pass outside the Royal Exchange near the Bank of England in the financial district of the City of London on July 2, 2021 in London, United Kingdom.

Mike Kemp | In the pictures | Getty Images:

LONDON — The market expects the Bank of England to raise interest rates by 75 basis points on Thursday. Its biggest increase since 1989But economists believe policymakers will be looking ahead as the prospect of a recession deepens.

Back UK inflation hits 40-year high of 10.1% in SeptemberThe bank is raising its key lending rate for the eighth consecutive time, but weaker growth and a major shift in fiscal policy are expected to dampen calls for more aggressive monetary tightening.

New Prime Minister Rishi Sunak he reversed the controversial tax cuts at the heart of previous Liz Truss’ fiscal policy agenda, meaning that fiscal and monetary policy are no longer moving in opposite directions.

Government reversals that eased market tensions mean the Bank’s Monetary Policy Committee (MPC) will not have to contend with the additional inflationary impact of government policy as it weighs the possibility of weaker growth ahead.

Goldman Sachs Economists on Monday cut their 2023 UK growth forecast to -1.4% from -1%, citing that there is likely to be less support for household and business energy costs under Sunak.

The Bank of England has set interest rates for the biggest rise in 33 years, but economists expect a cut

“Therefore, we see less pressure for the BoE to act aggressively at next week’s meeting, but we still believe a 75 basis point rate hike is likely, given that (1) fiscal policy is net more expansionary than was assumed. August MPR meeting, (2) news about labor market and underlying inflationary pressures has been steady, and (3) MPC commentary points to a sustained policy response at the November meeting,” Goldman’s economists said.

The Wall Street giant expects a split vote on Thursday in favor of a 75-basis-point hike, with some possibility of another half-point hike in December.

“We expect the MPC to attribute the pick-up in growth to continued inflationary pressures and additional support to demand from announced fiscal measures,” suggested UK chief economist Stefan Ball and chief European economist Jari Steen.

“However, we do not expect significant changes to the guidance going forward and look for the MPC to maintain its meeting-by-meeting approach.”

Deutsche Bank also expects a split vote on Thursday in favor of a 75-basis-point hike to 3%.

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In a note on Friday, the German lender said it expected the MPC to deliver three key messages to the market.

The first is that the economic outlook has worsened, with the UK economy now facing a “deeper and longer recession” than previously thought, while price pressures are likely to intensify in the short term to a crater by the end of 2025.

“Secondly, politics is not a predetermined path. However, risk management considerations warrant further tightening and prioritization of rate hikes given the increased volatility in inflation (expiration of the Energy Price Guarantee, due in March 2023), expansion. from price pressures and the pace of wage and price growth in the coming year,” said Sanjay Raja, chief UK economist at Deutsche Bank.

“As such, policy needs to go a bit further than expected, heading into restrictive territory, especially amid declining inflation expectations and strengthening second-round effects.”

The dangers of overstretching

Raja also noted that there are limits to monetary policy tightening, suggesting that a Bank Rate of 5%, as expected by markets, would cause balance sheet stress for households and businesses that are already struggling.

“We expect the MPC, including the governor at the press conference, to emphasize that while the Bank remains fully committed to tackling excess inflation, it will seek to avoid an excessive rate adjustment that would drag the economy back from its predecessor. epidemic level,” Raja added.

Deutsche Bank now expects the Bank Rate to reach 4.5% by May next year, down from a previous forecast of 4.75%, given the retreat of fiscal stimulus and a move towards fiscal consolidation.

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Bank of England Deputy Governor for Monetary Policy Ben Broadbent said in a recent speech that GDP would take a “fairly material” hit from such aggressive policy tightening. The Bank’s August growth forecasts, which already pointed to a five-quarter decline, were based on a much lower Bank rate of around 3%.

“The new set of forecasts, based largely on market interest rate expectations, are likely to be bearish, pointing to both a deep recession and below-target inflation over the medium term,” said James Smith, economist at ING Developed Markets.

“It should be seen as a not-so-subtle hint that market pricing is inconsistent with achieving the inflation target.”

Dovish Bank of England leaves pound vulnerable

Falling to a record low against the dollar after Liz Truss’ disastrous fiscal policy announcements at the end of September, the pound There was some relief from Sunak’s appointment and the retention of the more moderate finance minister, Jeremy Hunt.

Bond market remains fundamentally broken despite rise in UK gilts, says Jim Bianco

If Thursday’s 75 basis point hike is accompanied by dovish rhetoric, as economists expect, sterling could remain vulnerable given the market’s apparent overestimation of the terminal rate, according to BNP Paribas.

“Given the compression of GBP shorts over the past week, a significant BoE hike hardly bodes well for the currency. As such, we remain short GBP during the meeting,” strategists at the French lender said in a note on Monday.

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