The Bank of England Increased Rates for 5th Straight Time, Expects Further Rise in Inflation

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Fifth Straight Rate Hike

The Bank of England (BoE) delivered today its fifth consecutive 25 basis point increase in interest rates, bringing them at 1.25%. This marked the highest levels since January 2009 and the longest hike streak since 2007. [1]

Once more, the decision was not unanimous, since three officials of the nine-member committee dissented in favor of a more aggressive 0.5% adjustment, highlighting the division amongst them regarding the appropriate policy path to overcome the challenges faced by the UK economy.

The forward guidance changed from May, since the "some degree of further tightening in monetary policy may still be appropriate in the coming months" reference was removed. [2]

The new statement now notes - rather vaguely - that the Monetary Policy Committee (MPC) "will take the actions necessary" to bring inflation down to the 2% target "sustainably in the medium term". It added however, a more strong-worded passage, which states that the MPC will "act forcefully" in case of more persistent inflationary pressures.

Rampant Inflation

Inflation in the UK is shockingly high, with the Consumer Price Index having hit 9% in April (year-over-year), which is the highest since the Nation Statistics series began in 1997, while the new CPI update is expected next week.

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Rampant inflation is the main driver behind the BoE's rate hike cycle that started back in December, which it had been expecting to reach double-digits from the May projections, but today it went even further, announcing that it expects CPI inflation to rise to slightly above 11% in October

High Inflation is not unique in the United Kingdom given that it is largely caused by global events, but the BoE noted that "not all" of the excess inflation can be attributed to such factors. It went further, to comment that core consumer goods inflation (which excludes energy) is higher compared to the United States the Euro area.

GDP Contraction

The central bank did not only raise its inflation expectations, but it also lowered those for the economic growth, aggravating the already high fears of stagflation. It now sees GDP to shrink by 0.3% in the second half of the year, from the 0.1% growth projection in May.

In last week's updated forecast, the Organisation for Economic Co-operation and Development (OECD) projected the UK economy to grow by 3.6% in 2022, before stagnating in 2023, while seeing growth for most other major economies. [3]

Central Banking Differential

This creates pessimism around the UK economy and makes the central bank's job far more difficult, as it has to balance between surging inflation and potential recession. The BoE has stack to conservative 0.25% rate adjustments, which may be the worst of all worlds, since they seems to do little to combat inflation, while pushing towards recession.

The US Federal Reserve, which started its hiking cycle later than the BoE, has already brought rates to 1.5%-1.75% and bumped them by 75 basis points yesterday. This was the biggest move in nearly 30 years, triggered by the recent new inflation surge, and the Fed was not dissuaded by the Q1 GDP contraction.

Even the European Central Bank which is far behind than pretty much everyone in policy normalization, started to move due record consume prices. Despite Europe's exposure to the fallout from the war in Ukraine, the ECB announced a rate hike plan last week, to start with 25 basis points in July.

GBP/USD Reaction

Overall, this looks like a dovish announcement, since it lacked any explicit forward guidance for more tightening and the central bank seems to be running out road for more hikes.

The pair initially dropped after the new rate hike by the BoE, but then moved higher, as markets digest the decision.

it will likely be hard for GBP/USD to post a sustained recovery, given the BoE's doom and gloom and the unfavorable policy differential, while Brexit complications and political uncertainty in the UK may also work against it down the road. The pair is having a very bad year so far, losing more than 9% year-to-date, having hit 2+ year lows earlier in the week.

Nikos Tzabouras

Senior Market Specialist

Nikos Tzabouras is a graduate of the Department of International & European Economic Studies at the Athens University of Economics and Business. He has a long time presence at FXCM, as he joined the company in 2011. He has served from multiple positions, but specializes in financial market analysis and commentary.

With his educational background in international relations, he emphasizes not only on Technical Analysis but also in Fundamental Analysis and Geopolitics – which have been having increasing impact on financial markets. He has longtime experience in market analysis and as a host of educational trading courses via online and in-person sessions and conferences.

References

1

Retrieved 16 Jun 2022 https://www.bankofengland.co.uk/monetary-policy-summary-and-minutes/2022/june-2022

2

Retrieved 16 Jun 2022 https://www.bankofengland.co.uk/monetary-policy-report/2022/may-2022

3

Retrieved 03 Jul 2022 https://www.oecd-ilibrary.org/sites/62d0ca31-en/1/3/2/46/index.html

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