Bank of England Hikes Interest Rates by 25 Basis Points After Inflation Surprises

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  • The Monetary Policy Committee voted 7-2 in favor of raising the Bank rate to 4.25%, in a widely anticipated move after official data showed that U.K. inflation unexpectedly jumped to an annual 10.4% in February.
  • The Bank's Financial Policy Committee has determined that the British banking system "remains resilient" after recent bank failures in the U.S. and Switzerland.

LONDON — The Bank of England on Thursday hiked interest rates by 25 basis points as it grapples with persistent high inflation against the backdrop of concerns over the banking system.

The Monetary Policy Committee voted 7-2 in favor of raising the Bank rate to 4.25%, in a widely anticipated move after official data on Wednesday showed that U.K. inflation unexpectedly jumped to an annual 10.4% in February.

In its summary, the MPC highlighted that global growth is expected to be stronger than projected in its February Monetary Policy Report, while core consumer price inflation — which excludes volatile food and energy prices — has remained elevated.

The Bank of England estimates that additional fiscal support announced in Finance Minister Jeremy Hunt's Spring Budget last week will increase the level of the U.K. GDP by around 0.3% over the coming years.

"GDP is still likely to have been broadly flat around the turn of the year, but is now expected to increase slightly in the second quarter, compared with the 0.4% decline anticipated in the February Report," the MPC said in its report.

"As the Government's Energy Price Guarantee (EPG) will be maintained at £2,500 for three further months from April, real household disposable income could remain broadly flat in the near term, rather than falling significantly."

The Bank highlighted that much of the surprising strength in core goods prices indicated in Wednesday's inflation report could be attributed to clothing and footwear prices, which "tend to be volatile and could therefore prove less persistent.

Meanwhile the labor market has remained tight, and the Bank now anticipates that employment growth in the second quarter will be stronger than previously projected, while the unemployment rate will be flat rather than rising.

Sterling climbed against the dollar shortly after the decision before paring gains to trade around 0.2% higher.

UK banking system 'remains resilient'

The U.S. Federal Reserve also increased its key rate by 25 basis points on Wednesday and suggested that "some additional policy firming may be appropriate." It acknowledged the likely impact of recent problems in the banking system.

The Swiss National Bank lifted its own policy rate by 50 basis points to 1.5% on Thursday, while the European Central Bank hiked by 50 basis points last week in the midst of the banking sector turmoil.

Central banks around the world have been monitoring the fallout from the collapse of U.S.-based Silicon Valley Bank and the emergency rescue 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 has determined that the British banking system "remains resilient."

The FPC assessed that the U.K. banking system "maintains robust capital and strong liquidity positions, and is well placed to continue supporting the economy in a wide range of economic scenarios, including a period of higher interest rates."

"Reflecting these developments, bank wholesale funding costs have risen in the United Kingdom and other advanced economies," the MPC said in the Thursday report.

"The MPC will continue to monitor closely any effects on the 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 that the MPC was right to raise rates by 25 basis points.

"It is possible that recent concerns in the global banking sector will serve to tighten credit conditions, but that is not guaranteed," she said.

"As with the ECB last week and Fed last night, the Bank of England acted on the information it had today which is that the economy is still resilient, inflation is uncomfortably high and broadening, and wage growth is at a level that is inconsistent with a 2% inflation target."

However, JPMAM is concerned that the Bank will find itself "outside of the central bank herd" in the second half of 2023. The asset manager said that inflation appears more persistent in the U.K. 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."

In contrast, Goldman Sachs Asset Management sees these risks subsiding and on Thursday put forward the case for a pause in interest rate hikes, given the expected drag on growth from prior monetary policy tightening and financial market volatility.

"Big picture, the U.K. economy has contended with a series of large supply shocks in recent years, including Brexit, the pandemic, the energy price shock and decline in labour supply," said Gurpreet Gill, macro strategist for global fixed income at GSAM.

"These headwinds are fading to varying degrees and supply side reforms included in the Spring Budget support the case for better outcomes on inflation ahead."

Vivek Paul, U.K. chief investment strategist at BlackRock Investment Institute, said that, alongside the actions of the Fed and the ECB, the Bank of England decision to hike showed the global economy is in a "new regime."

"Central banks will not ride to the rescue with rate cuts at the first sign of growth concerns, as we've been used to for a generation. Financial stability (stabilising the system given banking concerns, or in the U.K.'s case last year, the gilt yield spike) and monetary policy actions (dealing with inflation) are distinct," he said.

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