In what is the most eagerly anticipated monetary policy meeting for years, the Bank of England will this week announce its latest decision on interest rates alongside new forecasts for the UK economy.
The BoE’s last interest rate meeting on September 22 just preceded one of the most turbulent periods in recent UK economic history. Liz Truss’s “mini” Budget involving £45bn of unfunded tax cuts sent government borrowing costs soaring, prompted a BoE emergency intervention, and resulted in higher mortgage rates for homeowners.
New prime minister Rishi Sunak is promising a new economic strategy in the government’s autumn statement on November 17, focused on showing how debt will fall as a share of gross domestic product in the medium term.
The BoE Monetary Policy Committee will therefore, by not having full details of Sunak’s strategy, be to a large extent “flying blind” when it unveils its interest rate decision on Thursday. Below are four things to look out for.
The interest rate decision
The nine MPC members will vote on how much to raise the official overnight interest rate from its current level of 2.25 per cent in response to high inflation.
Financial markets are betting on a 0.75 percentage point increase to 3 per cent, which would be the largest rise since 1989 and take it to the highest level since the global financial crisis in 2008.
An increase of that size would match the European Central Bank’s interest rate rise last week as well as expectations for the Federal Reserve’s likely move on monetary policy on Wednesday.
UK economic data has not changed much over the past six weeks, with inflation at a 40-year high of 10.1 per cent in September and the labour market remaining buoyant, but surveys of business activity have weakened sharply.
The central issue is the extent to which Sunak’s government is planning immediate tax rises and spending cuts, in moves that would take money out of the economy and damp inflationary pressures. Such actions would weaken the need for a large interest rate rise now.
If much of Sunak’s fiscal tightening is earmarked for after the next election, which is likely to take place in 2024, the MPC would want to take firm action against inflation immediately.
As BoE governor Andrew Bailey warned this month, the central bank will be “flying blind” because the government has not taken important decisions on the public finances yet.
Reflecting these uncertainties, the majority of economists expect MPC members to raise the bank rate by 0.75 percentage points on Thursday.
Samuel Tombs, economist at Pantheon Macroeconomics, said he expected “the MPC to hike bank rate by 0.75 percentage points, but to signal smaller hikes at future meetings”.
Expectation management on monetary policy
As important as the interest rate decision on Thursday will be the signals the MPC sends about the likely future path of monetary policy once the government has published its autumn statement.
Most economists think the BoE will attempt to persuade markets that it does not have to raise interest rates as high as they currently expect. Traders are betting on rates peaking at 4.75 per cent in the summer of next year.
This month Ben Broadbent, deputy BoE governor for monetary policy, cast doubt on markets at that time pricing in rates rising above 5 per cent, saying this would cause a recession that would be deeper than needed to bring inflation back to the central bank’s 2 per cent target.
Ross Walker, economist at NatWest, said Broadbent being “sceptical about market pricing of . . . bank rate above 5 per cent” was important in his forecast that rates would peak at 4.25 per cent.
Forecasts on economic growth and inflation
In August, the BoE shocked the nation by predicting inflation hitting 13 per cent by the end of 2022, a protracted recession and the worst squeeze in living standards for 60 years.
With the government’s cap on household energy bills serving to limit the rise in prices in the short term, the BoE inflation forecast may be pared back. But the central bank is still expected to suggest the economy is heading into a recession later this year.
The forecasts are unusually difficult for BoE officials to piece together, because it is unclear what the government’s policy is on taxes and spending amid volatile markets.
To underpin its forecasts, the BoE normally uses market prices — including expectations of future interest rates — from a 15-day period that expires just over a week before an MPC meeting. In relation to the November 3 meeting, this period would include the aftermath of the “mini” Budget turmoil, making the forecasts appear worse than they need be.
BoE officials will therefore have to choose whether to ditch the BoE’s normal forecasting conventions to produce predictions that reflect how calm has returned to markets in recent times.
Andrew Goodwin, economist at Oxford Economics, said there was a good chance the BoE would “look through” such oddities in its forecasting conventions to produce predictions that were more helpful in explaining the central bank’s policy decisions.
Quantitative tightening
In September, the MPC agreed the BoE would sell government bonds it had bought during waves of quantitative easing to boost the economy following the financial crisis and Covid pandemic.
The BoE proposed to reduce the £838bn stock of bonds at a rate of £80bn over the following year, so as to shrink the central bank’s balance sheet.
But the plan was derailed by the turmoil following Truss’s “mini” Budget, when the BoE had to intervene to buy up to £65bn of long dated gilts to shore up parts of the pension industry that were threatened with insolvency as yields spiked sharply.
The BoE said this month it would start its bond selling in November, with the focus on short and medium dated gilts. It said it would hold off from selling long-dated bonds.
Sanjay Raja, economist at Deutsche Bank, said he expected the MPC on Thursday to “confirm its commitment to active quantitative tightening”.
