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Financial markets and economists are expecting the Bank of England to raise interest rates by another quarter point at its meeting on Thursday, taking the cost of borrowing to 5.5 per cent, its highest level since early 2008.
The rise would follow a similar move from the European Central Bank last week, despite comments from BoE rate setters over the past month that were designed to give them the option to hold rates at 5.25 per cent.
The near certainty among economists and financial markets reflects the BoE’s guidance that they would raise rates again if there were further signs of persistent inflation, which have been seen in the latest wage and cost of services data.
This evidence jars with the signals coming out of Threadneedle Street in recent weeks. Many members of the bank’s Monetary Policy Committee have sought to create some doubt over the September decision now that borrowing costs are sufficiently high to bear down on economic growth and inflation.
BoE chief economist Huw Pill said inflation would fall if the BoE raised rates further and then had to cut them, as financial markets expect, or if the BoE paused and kept them at current levels for an extended period. He said he “tend[ed] to favour” the latter.
Giving evidence to MPs this month, governor Andrew Bailey and his deputy Sir Jon Cunliffe agreed that interest rates were “much nearer the top of the cycle”.
A fourth MPC member, Swati Dhingra, indicated she thought interest rates had already risen too far and there was a serious risk of over tightening.
Even though four of the nine MPC members expressed views that they were not certain rates needed to rise further, economists said that the data since the rate setters’ meeting in early August had been too inflationary for the BoE to pause immediately.
Private sector wage growth of 8.1 per cent in the year to July and services inflation of 7.4 per cent were both well above the BoE’s forecasts in August.
But the 15th rate rise in this cycle could well be the last. Paul Hollingsworth, chief Europe economist at BNP Paribas, said he expected “a dovish hike” to 5.5 per cent alongside guidance that the majority of the committee now thought rates probably did not need to rise further.
Capital Economics said a quarter-point rise “will be the last in this cycle” while Deutsche Bank said that after the BoE raised rates to 5.5 per cent on Thursday, “the door for a pause is open”.
Financial markets have moved to take the same position. At the end of last week, they were still pricing in a quarter-point rise in rates on Thursday and viewed this as the peak for now. In contrast, after the MPC’s August meeting, markets were still expecting rates to reach 5.75 per cent this year.
Krishna Guha, vice chair of Evercore ISI, said that although there had been a co-ordinated effort to persuade everyone there was no need for many more rate rises, the data did not yet justify a pause.
The big unknown for economists both inside and outside the BoE is the August inflation data, which will be published early on Wednesday, a day before the rate decision is announced.
The rate of price growth stood at 6.8 per cent in July and is expected to tick higher to about 7.1 per cent as a result of a rise in petrol and diesel prices last month, as well as increases in the duty on alcohol.
The slight rise in inflation is unlikely to concern the policymakers because it was in the bank’s August forecasts, but the MPC will be watching the trend in the services sector data particularly closely.
The bank views price growth of domestic services, especially areas such as restaurants and hotels, as a strong guide to underlying inflationary pressure. Inflation in this area has been rising steadily and it would take a sharp improvement in the August data for the MPC to vote for a pause.
Other big developments in economic data over the past month are likely to be glossed over by the MPC, economists said. They said that the revisions that showed the UK economy performed almost 2 per cent better than previously thought in 2020 and 2021 combined were unlikely to change the MPC’s view of inflationary pressure.
Andrew Goodwin, chief UK economist at Oxford Economics, said the upgrades were more likely to change policymakers’ views of how fast the economy could grow without generating more inflation rather than make them think that there were greater pricing pressures this year. “It’s not clear that the revisions will affect the MPC’s stance on interest rates,” he said.
Along with the decision on rates, the MPC must also decide how many gilts the BoE will sell in the coming year in its quantitative tightening process.
This is a one-off, annual event at the September meeting designed to give government bond markets certainty about the supply of gilts. Over the past 12 months, the bank shed £80bn from its balance sheet, made up of £34bn in sales and £46bn of maturing gilts.
Sir Dave Ramsden, BoE deputy governor for markets, has said he expected the scale of quantitative tightening over the next 12 months to exceed £80bn. He has previously said that the £34bn in gilt sales in 2022-23 had no material effect on borrowing costs because the amount was small compared with the government’s £252bn gross financing requirement this year.
