Bank of England Surprises Markets by Holding Rates at Record Lows

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  • The Bank's Monetary Policy Committee voted 7-2 to keep its benchmark interest rate unchanged at its historic low of 0.1%.
  • Sterling fell sharply following the announcement.
  • The Bank of England has been monitoring a confluence of crucial data points as inflation remains persistently high.

LONDON — The Bank of England held interest rates steady on Thursday, defying many investors' expectations that it would become the first major central bank to hike rates following the coronavirus pandemic.

The Bank's Monetary Policy Committee voted 7-2 to keep its benchmark interest rate unchanged at its historic low of 0.1%, and 6-3 in favor of continuing the existing program of U.K. government bond purchases at a target stock of £875 billion ($1.2 trillion). The MPC voted unanimously to maintain its £20 billion stock of corporate bond purchases, keeping the total asset purchase program at £895 billion.

Markets had been uncertain as to whether the Bank would set off on the path toward monetary policy normalization on Thursday or at its next meeting in mid-December, but analysts broadly agreed that a hike was due before the end of the year.

Sterling fell sharply following the announcement. It was last seen down by around 0.95% against the dollar at 1.3551, while the euro gained 0.4% on the pound.

The Bank of England has been monitoring a confluence of crucial data points as inflation remains persistently high while economic growth moderates and labor conditions tighten.

"The Committee judges that, provided the incoming data, particularly on the labour market, are broadly in line with the central projections in the November Monetary Policy Report, it will be necessary over coming months to increase Bank Rate in order to return CPI inflation sustainably to the 2% target," the MPC said in its summary on Thursday.

Labor market difficulties

The Bank noted that "a high degree of uncertainty" about the near-term outlook for the labor market, following the end of the country's furlough scheme on Sept. 30, was a key factor in its decision. Unemployment fell to 4.5% in the three months to August while payroll data rose strongly.

"Just over a million jobs are likely to have been furloughed immediately before the Coronavirus Job Retention Scheme closed at end-September, significantly more than expected in the August Report," the Bank explained.

"Nonetheless, there have continued to be few signs of increases in redundancies and the stock of vacancies has increased further, as have indicators of recruitment difficulties."

U.K. job vacancies hit a record 1.1 million in the three months to August, while the unemployment rate fell. A tight labor market has been supportive of higher wage growth, a message echoed by business leaders in recent weeks.

"We expect a hike in rates to come through in December, when policy makers will have at least some tentative evidence on how employment has performed after the expiration of furlough," said Luke Bartholomew, senior economist at Abrdn.

"And indeed further rate increases next year. So the message to investors is that rate hikes are coming soon, but not to hang too closely to every speech and interview by rate setters."

Inflation surge

British inflation slowed unexpectedly in September, rising 3.1% in annual terms, but analysts expect this to be a brief respite for consumers. August's 3.2% annual climb was the largest increase since records began in 1997, and vastly exceeded the Bank's 2% target.

The Bank now expects inflation to rise further to around 5% in the spring of 2022 before falling back toward its 2% target by late 2023, as the impact of higher oil and gas prices fades and demand for goods moderates.

GDP grew 0.4% in August after an unexpected contraction of 0.1% in July, as staff absences linked to the Covid-19 Delta variant surged.

Speaking to CNBC at the COP26 climate conference ahead of Thursday's decision, Standard Chartered CEO Bill Winters said he believed that inflation is now structural rather than transitory.

"I see wage pressure pretty much everywhere we go, we see labor shortages, and of course there's friction costs, that should iron themselves out over time, there's energy prices, which I think are going to remain high for quite some time because economic activity is strong," Winters said.

"That to me says that inflation expectations are becoming ingrained."

However, while the Bank gave a firm indication that a rate hike is imminent, it pushed back on market pricing that expects the benchmark rate to increase to around 1% by the end of next year.

"The Bank of England's inflation forecasts under this assumption of market pricing shows inflation falling below the target over the forecast horizon, indicating it views that pricing as overzealous," said Ambrose Crofton, global market strategist at JPMorgan Asset Management.

As visibility on the duration of supply chain disruptions remains low, Crofton highlighted, the Bank's inflation outlook is still foggy. Meanwhile, it will be seeking clarity on the extent to which the end of the furlough scheme can "provide some relief to an apparently tight labor market," he suggested.

"We think this leaves the Bank of England in a highly data dependent position where it won't be too wedded to a pre-determined timeline of normalising policy," Crofton said.

"Make no mistake though, interest rate lift-off is just around the corner."

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