11 May 2023
Today’s 25 basis points (bps) hike takes interest rates to 4.5%, the highest level in 15 years. But, there are some good reasons to think we have now reached the peak. The Bank of England (BoE) came out with a new set of pretty strong forecasts. It now thinks GDP will be a whopping 2.25% bigger in mid-2026 than it thought in February, that's the biggest upward revision in its forecast since it gained independence in 1997. It also now expects inflation to fall more slowly and the labour market to remain tighter.
Given that the Monetary Policy Committee (MPC) kept its guidance that there would have to be upward surprises for it to hike again, the new forecasts essentially set a higher bar for further rate hikes. Whether there are any more rate hikes then will fully depend on the data between now and the next meeting in June.
However, the committee maintained a bias towards tightening saying it "continues to judge that the risks around the inflation forecast are skewed significantly to the upside". Also, don't forget that the data has consistently surprised the MPC’s recent forecasts to the upside. Our feeling is that the inflation and labour market data over the next two months will be strong enough to prompt one more rate hike before a pretty long pause. We don't expect interest rates to start falling again until this time next year.
Stronger economy, tighter labour market, higher inflation
The MPC no longer expects the economy to fall into recession. Indeed, it revised up its forecast based on market rates for year-on-year growth in GDP to 0.4% in 2023 and 0.7% in 2024, from -0.5% and -1.0% respectively. The level of GDP expected in three years’ time now is 2.25% higher than anticipated in February. Even so, it still expects some spare capacity, equal to 1.0% of GDP, to emerge by 2025.
At the same time, it expects the unemployment rate to remain below 4% for the rest of this year, before rising to 5% by the end of 2024. The rise in the unemployment rate next year should cause a sharp slowdown in wage growth. The Bank now expects inflation to fall to 8.4% in April, before dropping all the way to 1.8% in two years’ time, well above the 1.4% the bank expected inflation to reach in February.
Higher bar for future rate hikes
The MPC left its guidance unchanged from the previous two meetings.
“The MPC will continue to monitor closely indications of persistent inflationary pressures, including the tightness of labour market conditions and the behaviour of wage growth and services inflation. If there were to be evidence of more persistent pressures, then further tightening in monetary policy would be required.”
Translating this from ‘Bank language’ this means - whether interest rates increase again in June depends on whether there is evidence that the labour market is easing, and inflation is cooling. The Bank is essentially saying if the economy evolves in line with our forecasts then we probably won’t need to hike again.
So, the stronger forecasts across the economy set a higher bar for future rate hikes as the economy would have to outperform them.
However, there is still a bias towards tightening on the committee. It views the risks as skewed to the upside for inflation and the committee deliberately did little to send a signal that this rate hiking cycle is now at an end.
What’s more, the economy has outperformed the MPC’s forecasts over the last six months or so and signs of inflation persistence haven’t been in short supply in recent months, suggesting the MPC’s battle with price pressure is a long way from over.
As a result, we anticipate one more hike before a lengthy pause. We doubt the BoE will be comfortable cutting rates until inflation is within touching distance of the 2% target. In our forecasts, that doesn’t happen until Q2 2024. We have assumed cuts of 25 bps a quarter from that point until the end of 2025, when interest rates may feel a bit friendlier again.