BoE hikes base rate to 1.75% as gloomy outlook warns of 13% inflation and recession

The Bank of England raised rates by 50 bps at their August monetary policy meeting to take the official rate to 1.75%. This move was in-line with market expectations and marks the sixth rate increase in as many meetings. At 0.5%, it is the largest rate rise we have seen from the Bank since June 1995.  Officials voted 8-1 in favour of the increase, with the single dissenter opting for 0.25% hike.

David Goebel, Associate Director of Investment Strategy at wealth manager Evelyn Partners, comments:

The accompanying inflation report and economic estimates paint a more difficult period ahead for the UK economy than the MPC had previously anticipated. They expect CPI inflation to rise to “over 13% in 2022 Q4, and to remain at very elevated levels throughout much of 2023, before falling to the 2% target two years ahead.”  On the economy, the Bank is predicting a recession that starts in the fourth quarter and lasts through next year.  This represents a deterioration on its May outlook, which predicted a few difficult quarters.

The 50bps increase shows the Bank of England catching up with larger interest rate moves from other central banks, particularly the Federal Reserve.  Although the BoE had the first mover advantage, beginning its hiking cycle in December last year, its reliance on smaller 25bp moves have left it behind the Fed who have delivered back-to-back 75bps increases at their last two meetings. The Bank also set out how it will shrink its balance sheet, suggesting it will begin outright sales of gilts after its September meeting.

Although the 9.4% June inflation print was driven by external factors, mainly global energy prices, this rate move signals the Bank is also concerned with domestic sources of inflation like wage growth. Continuing weakness in sterling, which has depreciated by around 10% year-to-date relative to the US dollar, increases the risk of further inflationary pressure.

However, policymakers are balancing this with concerns over weakness in the economy – demand in the UK labour market is easing, and energy prices are set to rise by as much as 70% in the autumn, when Ofgem’s next price cap comes into play. Softening consumer confidence points to weaker spending in the second half of this year, so declining growth could go some way to curtailing high levels of inflation in itself.

There is also a political angle to consider. Liz Truss, who bookmakers currently suggest has over a 90% chance of becoming the next prime minister, is vowing to cut taxes, which could stoke inflation further. She has also suggested she would look at changing the mandate of the Bank to make it more effective in fighting future inflation, but without detail on how as yet.

For investors in UK equities, the fortunes of the UK economy are less important than its sectoral composition. That’s because around two-thirds of its earnings are derived from overseas, while increasing rates tend to favour the value orientated sectors which the UK market has relatively high exposure to.

The biggest impact on UK investors will likely be through exchange rates, where weakness in GBP this year has been to their benefit. With continued expectations for interest rate increases from most central banks, it is difficult to see a markedly stronger pound in the near term.