16 December 2022
Today’s 50 basis points (bps) hike takes interest rates to 3.5%, the highest level in 14 years. But this smaller increase suggests that the end is in sight for the Bank of England’s (BOE) tightening cycle. However, the minutes of the meeting made it clear that, although the end is in sight, there are still more hikes to come. We expect rates to rise to 4.5% early next year and that they won't start to be cut again until early 2024.
The minutes of the Monetary Policy Committee (MPC) meeting stated, “the majority of the Committee judges that, should the economy evolve broadly in line with the November Monetary Policy Report projections, further increases in Bank Rate may be required for a sustainable return of inflation to target.” In other words, as long as there are no economic surprises, expect only a few more rate hikes.
The wording is almost identical to what the MPC issued in November. It suggests more hikes are likely in coming months and that larger-than-25-bp moves are still on the table. The key difference is that, unlike in November, the Committee chose not to comment on the level of market pricing. This is probably because market interest rate pricing has come down significantly since its recent high.
Admittedly, the MPC was still heavily divided. The vote split was: 1 for +75bps, 6 for +50bps, 0 for +25bps and 2 for no change, with Catherine Mann preferring a 75-bps hike. Swati Dhingra and Silvana Tenreyro favoured no increase. However, the switch back of two members — Dave Ramsden and Jonathan Haskel — to the consensus vote, having sought 75bp hikes at recent meetings, points to an emerging broad-based consensus that the terminal rate is approaching.
Even though inflation has peaked and is now starting to fall, it will probably be 2024 before it is back at the Bank’s 2% target. But the most crucial factor will now be the labour market. If the early signs that the labour market is loosening are borne out over the next few months, then rates may not need to rise much above 4%. Afterall, interest rates have now risen by 340bps in a year, which is more tightening than in any cycle since the late 1980s. The big risk is that wage growth proves stickier than anticipated, which may force the Bank to tighten policy further.
However, with inflation likely to fall sharply over the next six months and the recession likely to take some heat out of the labour market, we doubt the MPC will need to continue to raise rates beyond the 4.5% terminal rate we expect early next year. Even with the economy struggling, 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.