The Bank of England Accelerated the Pace of Tightening in Response to Another Hot Inflation Report

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Tightening Acceleration

The Bank of England has been raising interest rates non-stop since the October 2021 lift-off in order to contain inflation, but had recently moderated the speed tightening with a two straight 0.25% moves. Today however, it reaccelerated its pace, with a more forceful 50 basis points increase. [1]

This action brought rates to 5.0% and the highest levels since 2008. In typical BoE fashion, the decision was not unanimous. A minority of two members voted to keep rates unchanged, in a 7-2 split decision.

The aggressive action, was against baseline expectations, but was definitely not a surprise, as it came in response to strong labor data and hot inflation report.

High Inflation

Wednesday's Consumer Price Index (CPI) data came in higher than expected. Headline inflation stabilized to 8.7% y/y in May, staying hoisted well above the central bank's 2% target. Even worse, the core reading, which excludes energy, food, alcohol and tobacco prices, jumped 7.1% in the biggest increase since 1992.

Although the BoE anticipates inflation to fall "significantly further" in the course of the year, it had actually upgraded its forecasts last month, with risks "skewed significantly to the upside". It projects CPI inflation to moderate to 5% in 2023 (from 4% previous forecast) and does not expect it to fall below 2% before 2025. [2]

Elevated Wages

The labor market meanwhile remains tight as last week's strong report revealed. Unemployment ticked down to 3.8% in the tree-month period ending April. Most importantly though, average weekly earnings rose 6.5% in the biggest increase of the year, while excluding bonuses, wages surged 7.2%, in the "largest growth rate seen outside of the coronavirus (COVID-19) pandemic".[3]

Elevated total and regular pay has been a constant headache for the Bank of England, fearing a wage-price spiral. Governor Bailey had hinted to such risk last month, taking note of second-round effects that are "unlikely" to go away quickly. [4]

Open To More Hikes

Policymakers took decisive action today to try and contain inflation, following a recent period during which they seemed to be hiking reluctantly. Unsurprisingly, they remained non-committal around the policy path, but reiterated that "further tightening in monetary policy would be required" in case persistent pressures on inflation.

With inflation repeatedly surprising to the upside and tight labor market with high wages, the central bank will have a hard time pausing its rate hike cycle. However, the next decision is not due until early August and officials will have a slew of data to consider.

Potential Pitfalls

The current situation puts pressure on policymakers for more monetary firming, but they may want to tread carefully. In their effort to mitigate the high cost of living, they risk triggering a borrowing crisis.

Higher bank rates make every type of household credit more expensive, but even more so, many homeowners feel the pain from rising mortgages. A few days ago, Moneyfact said the average two-year fixed mortgage rate hit 6% on Saturday, which is the "highest it's been since December last year". [5]

Earlier in the month, the Financial Conduct Authority (FCA) found that loans in arrears increased substantially in the first quarter, nearing £14.9 billion. [6]

UK's Two-year bond yields meanwhile, a measure of short-term government borrowing costs, surged to the highest in fifteen years. As such, they surpassed the levels that had been reached after September's "mini-budget" debacle that eventually led then PM Truss to step down.

Market Reaction

UK100 is having a bad week and today's aggressive rate hike by the BoE keeps it under pressure. GBP/USD reacted higher initially, but quickly erased the gains. Continued monetary tightening has been a source of strength for the British pound, but fears of the impact to the economy can contain it.

Nikos Tzabouras

Senior Financial Editorial Writer

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 22 Jun 2023 https://www.bankofengland.co.uk/monetary-policy-summary-and-minutes/2023/june-2023

2

Retrieved 22 Jun 2023 https://www.bankofengland.co.uk/monetary-policy-report/2023/may-2023

3

Retrieved 22 Jun 2023 https://www.ons.gov.uk/economy/inflationandpriceindices/bulletins/consumerpriceinflation/may2023

4

Retrieved 22 Jun 2023 https://www.bankofengland.co.uk/speech/2023/may/andrew-bailey-keynote-speech-british-chambers-of-commerce-global-annual-conference

5

Retrieved 22 Jun 2023 https://moneyfactscompare.co.uk/news/mortgages/average-two-year-fixed-deal-hits-6/

6

Retrieved 21 Feb 2024 https://www.fca.org.uk/data/commentary-mortgage-lending-statistics-q1-2023

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