Author: Elliot Smith
Article: Bank of England set for biggest rate hike in 33 years, but economists expect dovish tilt
Publication date: Wednesday, November 2, 2022
The market expects the Bank of England to raise interest rates by 75bp on Thursday, which will be the biggest increase since 1989, but economists think that policymakers will stick to a dovish tone, expecting a deepening recession.
Given that inflation in the UK reached a 40-year high of 10.1% in September, the Bank is likely to raise its main lending rate for the eighth time in a row, but weaker growth momentum and major changes in fiscal policy are expected to weaken calls for more aggressive action.
Rishi Sunak, a new Prime Minister of the UK, has repealed the controversial tax cuts that underpinned his predecessor Liz Truss's fiscal policy agenda, meaning fiscal and monetary policy will move in the same direction from now on.
The government's U-turn, which has eased market tensions, means that the Bank's Monetary Policy Committee (MPC) will not have to counteract the additional inflationary pressure from government policy since it admits the probability of weaker growth in the future.
On Monday, economists at Goldman Sachs lowered their 2023 growth forecast for the UK from -1% annualized to -1.4%.
According to a statement by Goldman economists, they see less pressure on the Bank of England to act aggressively at next week's meeting, however, they still believe that an increase to 75 basis points is likely, taking into account that fiscal policy is generally more expansionist than anticipated at the August MPR meeting; news on the labor market and inflationary pressures have been steady; and the MPC's comment points to a strong political response at the November meeting.
Deutsche Bank expects the bank rate to reach 4.5% by May next year, compared with its previous forecast of 4.75%, due to the rejection of fiscal incentives and the striving for fiscal consolidation.
In his recent speech, Ben Broadbent, the BoE's Deputy Governor for Monetary Policy, declared that GDP would take a "pretty substantial" blow from such aggressive policy tightening. The Bank's growth projections for August, which already pointed to a five-quarter recession, were based on a much lower bank rate of around 3%.
According to James Smith, an economist at ING Developed Markets, the new set of forecasts, which are based heavily on expectations of market interest rates, are likely to be negative, showing not only a deep recession, but also a drop in inflation below the target level in the medium term.
He also added that this should be regarded as a not very subtle hint that market pricing is incompatible with achieving the inflation target.
According to BNP Paribas, if Thursday's 75bp increase is accompanied by dovish rhetoric, as many economists expect, the pound could remain vulnerable, taking into account the obvious overstatement of the terminal rate by the market.
BNP Paribas analysts said in their note that taking into account the reduction of short positions on the pound sterling last week, a "dovish" increase by the Bank of England is unlikely to be a good sign for the currency. Thus, they maintain a short position on the pound sterling into the meeting.
An increase in the rate will only lead to a short-term increase in the GBPUSD rate.
If the Bank of England's release contains theses about further policy easing, then GBPUSD will decline by the end of 2022.