News & Analysis

The Bank of England surprised market participants today by voting 8-1 to raise rates by 15bps to 0.25%, and has effectively announced the start of their hiking cycle in spite of the growth risks posed by the Omicron variant.

Prior to today’s meeting, both traders and economists had largely reversed their expectation of a December rate hike due to the risks posed by the arrival of the variant, but the Bank of England opted to look through the demand-side impact and instead focus on positive developments in the labour market post-furlough and the inflation risk posed by rising cases on the supply-side. Reflecting the demand-side risks, the Bank has revised down its expectation of Q4 growth from November’s monetary policy report by 1.5%, meaning the economy is unlikely to return to pre-pandemic levels of output until 2022 in their eyes. Additionally, the Bank has raised its projection of peak inflation from 5% to 6% in light of the November CPI print and upcoming inflationary risks, due to tighter containment measures.

While the Bank insisted there was some option value in waiting for further information on the Omicron variant, there was a strong case for tightening monetary policy now, given the strength of underlying inflationary pressures.

This will be a bitter pill for some business owners within the services sector to swallow as demand is likely to fall leading into Q1, as highlighted by this morning’s preliminary services PMI data, while input costs and underlying interest rates rise. Further concerns are likely to arise from the tightening of financial conditions beyond the initial 15bps rate hike as markets view the Bank of England in a more hawkish light due to their decision to move on policy despite the elevated risk to their forecasts. This is visible in the rise in longer-term Gilt yields, while money markets have been encouraged by today’s decision and have proceeded with pricing in a further 15bps of rate hikes in February and as much as 88bps in 2022.

While the Bank’s decision today did go against our expectations, largely due to their sensitivity to the inflation backdrop, we think their reference to today’s rate hike as “finely balanced” suggests that a subsequent rate hike is unlikely in February.

Rates remaining below 50bps prior to March has been our longstanding view given the large level of Gilt maturities due and the Bank’s commitment to cease reinvestments at the 0.5% level. This may limit further GBP upside against the dollar, with sustained sterling strength likely to be visible against the euro this afternoon should policy divergence become more visible with the ECB decision at 12:45 GMT.

 

Sterling shoots higher as the BoE surprises markets with a 15bps rate hike

 

Money markets are now implying rates will sit above around 1.25% by Dec 2022

 

Author: Simon Harvey, Senior FX Market Analyst

We spoke to Reuters to discuss the announcement. You can read the full coverage here

 

 

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