22 June 2023
By raising interest rates by a bumper, above-expectations, 50 basis points (bps) today to a fifteen year-high of 5%, the Monetary Policy Committee (MPC) is demonstrating its inflation fighting credentials, as well as attempting to suck more demand out of the economy. If interest rates do go to 6%, as financial markets expect, that would be enough to tip the economy into a recession.
The size of the hike along with the lack of push back against financial markets pricing in a peak of 6% suggests that this won’t be the last rate hike this year. But the language in the minutes to the MPC meeting suggests that 50 bps isn’t necessarily the default and the size of further rate hikes will depend on the data.
Our forecast of a 5% peak in interest rates is clearly out of date. We are still sceptical that interest rates will need to go all the way to 6% to dampen inflation. But, the recent data outturns and the lack of hesitation by the MPC to revert back to a 50 bps rise suggests that this is now a real possibility – that would be enough to tip the economy into recession.
Hawkish forward guidance
The committees forward guidance was largely unchanged, saying that “the risks around the inflation forecast are skewed significantly to the upside” and that “if there were to be evidence of more persistent pressures, then further tightening in monetary policy would be required”. Combine this with the letter that Bank of England (BoE) Governor, Andrew Bailey, sent to the Chancellor, where he said “he will do what is necessary to return inflation to the 2% target”, the MPC is sending a clear message that it is determined to get inflation back under control.
Indeed, it was notable that the MPC didn’t push back at all against market expectations of a peak of 6%, despite having previously pushed back against lower expectations. This could be because the MPC is happy to let tightening financial conditions do some of its work, but clearly a majority of the committee no longer see 6% as an outlandish proposition.
But the MPC’s guidance also makes it clear that it is the data that will determine whether, and how large, any more rate hikes need to be.
The ongoing concerns about inflation persistence means we doubt the majority of the MPC will be comfortable calling time on the hiking cycle until there is a clear downward trend in core and services inflation. According to our forecast that doesn’t happen until Q4 23. That means the August and September meetings all now look like they will result in action – and don’t rule out November either.
Indeed, unless the economy materially weakens before August a rate hike then looks very likely. Our base case is the committee could revert back to a 25 bps rise but it wouldn’t take much to tip this into another 50 bps one.
However, the MPC is also likely to become more cautious about the impact of previous rate hikes on the economy. After all, the MPC acknowledged that “the greater share of fixed-rate mortgages meant that the full impact of the increase in Bank Rate to date would not be felt for some time.” With at least 800,000 fixed mortgages due to move on to significantly higher rates in the second half of this year there is clearly a lot more pain to come for households.
For now, we are expecting a 25 bps in both August and September, which would take interest rates to 5.5%. But given the MPC showed no hesitation in voting for a 50 bps rise today, the stickiness of core inflation and the likelihood that the labour market will remain tight for a while – 6% no longer seems such a stretch. That would probably be enough to tip the economy into recession, but the MPC has been clear that it is willing to pay that price if it means getting inflation back to 2%.