UK Interest Rate Rise: Not the End of the Inflationary-curbing Road

Aug 3rd 2023

It had been expected. The Bank of England has announced it is hiking interest rates for the 14th consecutive time this cycle to 5.25%, as it continues to fight the G7’s highest inflation rate. 

July UK inflation data was more positive than anticipated, but headline Consumer Price Index (CPI) and services inflation remained consistently higher than the Bank of England’s expectations. 

Following the Monetary Policy Committee meeting, the Bank of England today (3 August) confirmed it is raising its base rate by a further 25 basis points, in line with earlier announcements from the European Central Bank (ECB) and the Federal Reserve. 

Market analysts generally expected the Bank of England would follow the steps of the ECB and the Fed this month – they also hiked their borrowing costs by 25 basis points – but the UK’s future rate-setting trajectory remains decidedly uncertain. 

So, what can cash holders expect from the Bank of England in the next few months, and how different could the UK’s base rate course be? 

The ECB and the Fed have recently indicated that their tightening cycle could soon come to an end. Experts believe the ECB, which deposit rate now sits at 3.75%, could be setting the stage for a pause in rate-rises in the eurozone in September. 

The US, meanwhile, pushed their benchmark interest rates to 5.5% to a 22-year high this month, and the Federal Open Market Committee indicated that it would consider rate-rising for a 12th time in September before potentially pausing its policy. 

Federal Reserve Chair Jerome Powell told reporters, “it is certainly possible that we would raise funds again at the September meeting if the data warranted […] And I would also say it’s possible that we would choose to hold steady at that meeting.” 

Both zones have witnessed retreating inflation – in the eurozone, inflation has fallen to 5.5%, while US inflation fell to 3% in June, down from 9.1% in June 2022. It seems that disinflation measures in the eurozone and the US have been tricking down, although data remains in excess of their 2% target. 

In the UK, however, economists have shared their concerns that the increase in borrowing costs has yet to feed through the economy as quickly as the Bank of England had expected.  

Inflation remains at 7.9%. CPI is higher than expected at 8.7%. Wage growth sits at 7.2% – much higher than in the US and the eurozone at 4.4% and 5.2%, respectively. The labour market is thought to remain tight until at least late-2024. Growth remains slow, and the uncertainty surrounding energy prices persists. The Bank of England is facing political pressure. The bank even announced an external review of its “forecasting and related processes during times of significant uncertainty.” 

Megan Greene, an external Monetary Policy Committee member, wrote in the Financial Times that “it would be a mistake for central bankers to take comfort in the notion that inflation and (interest) rates will automatically go back to the low levels we saw before the pandemic.” 

In June, Greene also warned: “If you engage in stop-start monetary policy, you may end up having to tighten even more and generating an even worse recession on the other side.” 

Given the unease, we anticipate further impact on mortgage rates, but the Bank of England’s obsession with subduing inflation to 2% could also mean cash holders could continue to benefit from this ultra-high interest rate environment – including further hikes – for the remainder of 2023, even as the ECB and the Fed policymakers start curbing their monetary tightening cycle. 

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