The Bank of England delivered a 50-basis-point interest-rate hike on Thursday, defying market expectations of a quarter-point increase, as the bank continues its battle to get inflation under control.
The BOE’s monetary policy committee members, which set policy to meet the central bank’s 2% inflation target, voted at its meeting Wednesday 7-2 to raise rates to 5%.
The bank said gilt yields have risen “materially” since its May and June meetings, which suggest a “path” for the bank rate that averages around 5.5%.
Although annual inflation has pulled back from double digits, it was still at 8.7% in May — unchanged from April. However, consumer price index inflation is expected to fall “significantly further during the course of the year, in the main reflecting developments in energy prices,” the bank said in an update Thursday.
“The MPC will continue to monitor closely indications of persistent inflationary pressures in the economy as a whole, including the tightness of labor market conditions and the behavior of wage growth and services price inflation. If there were to be evidence of more persistent pressures, then further tightening in monetary policy would be required,” the bank said.
The announcement caused a “fresh round of turbulence,” said Susannah Streeter, head of money and markets at Hargreaves Lansdown, in an emailed comment. Two-year gilt yields fell below 5% before shooting back up above 5.1%, “as uncertainty reigns about how far rates will go.” Investors are trying to assess whether the “big bazooka” delivered Thursday “might be enough to stem further rate hikes or whether more will still be necessary,” she said.
The pound sterling also had a case of the jitters, she said, citing a sharp rise to $1.283 before falling 0.5% to $1.276. “Volatility is set to remain the order of the day as investors assess what impact this hawkish move will have on the U.K. economy,” Ms. Streeter said.
Following the publication of the inflation data, published Wednesday by the Office for National Statistics, money managers had said their expectation was still for a 25-basis-point rise, but that the likelihood of a 50-basis-point increase had grown.
Managers on Thursday then cited the data as being the factor that forced the MPC’s hand in delivering a higher hike than anticipated.
“The deeply worrying core inflation print yesterday had meant a 0.5% hike from the Bank of England today was a necessity,” said Seema Shah, chief global strategist at Principal Asset Management, in an emailed comment. “For the Bank, there is no space for dithering or confusing messages now. The U.K. has the unenviable title of highest core inflation rate in the G7, and by quite some margin. It requires the central bank to adopt a clearly hawkish attitude that signals further sizable moves over the coming months, emphasizing the severity of the situation. A sharper slowdown of the U.K. economy will be an unfortunate, but necessary, fallout from monetary policy.”
Michael Metcalfe, head of macro strategy at State Street Global Markets, said in an emailed comment: “The BOE continues to chase inflation surprises. While more modest in absolute terms, the last three inflation prints have been more surprising than at any point last year. Even though inflation is still forecast and projected to fall, this disappointment has pushed the BOE back into 50 (basis-point) hikes. This does not necessarily mean that the end point for interest rates will be higher, simply that the current run rate of inflation requires action sooner rather than later.”
However, Mr. Metcalfe said there may be good inflation news coming, as the firm’s “measures of online inflation are already showing a significant moderation in U.K. inflation in the month of June, so we may once again have reached peak inflation fear.”
The increase “is a tacit admission that (the BOE) have been behind the curve in their hiking policy and this measure is an attempt to regain the initiative and their credibility,” said Huw Davies, investment manager, fixed income absolute return at Jupiter Asset Management, in an emailed comment. “The key problem is that U.K. real rates have consistently been negative despite the tightening cycle. It feels like the BOE will have to inflict more pain on U.K. households to achieve a return to a controlled level of inflation more in line with their inflation target,” he warned.