Interest rates look set to be held amid bond market pressure
The Bank of England is expected to leave Interest rates unchanged even as bond traders raised expectations for upcoming hikes and the Federal Reserve opted to tighten monetary policy in the US.
The Bank’s nine-member Monetary Policy Committee is expected to back leaving interest rates at 3.75 per cent although policymakers are set to be split.
On Tuesday evening, the Bank’s former chief economist urged policymakers to back an interest rate hike although he said it was a “coin toss” on whether borrowing costs would be lifted on Thursday or in November.
MPC members Huw Pill, Megan Greene and Catherine Mann are expected to stick to previous calls for an interest rate hike.
Some City forecasters believe Clare Lombardelli could join the trio.
Gilt yields have spiked in recent weeks. The two-year gilt yield, which is an indicator for short-term interest rate expectations, is at just over 4.6 per cent on Wednesday afternoon.
On Thursday, the Bank will also unveil plans on its quantitative tightening programme for the next year, the process by which gilt holdings are offloaded onto investors.
City analysts believe policymakers will vote to slow the sale of bonds after it reduced its annual target sales from £100bn in 2025 to £70bn this year. The Bank’s own analysis suggests it has added to pressure on gilt yields despite an insistence that the policy has worked in the “background” to key monetary policy decisions.
Officials are under pressure from politicians in Westminster, including the likes of deputy leader Richard Tice, to stop quantitative tightening altogether in order to protect taxpayers from absorbing immediate costs. Bailey has argued that different accounting methods would give the Bank more flexibility to deal with shocks in the long-term and allow for market distortions to be reduced.
Bank of England’s interest rates dilemma
Economists at the central bank got sight of a flurry of economic news in the last week. CPI inflation edged up to 3.1 per cent in the year to August as a result of a jump in fuel prices.
Deutsche Bank’s Sanjay Raja said new pricing data suggested there could be an interest rate hike on the horizon.
He suggested that “worrying trends” in services prices, such as in private rents and health costs, could squeeze budgets.
Relative to the Bank of England’s own central judgments, “inflation momentum is running hotter than expected”, Raja said.
“Rates may be restrictive, but the key policy question for the MPC will remain: are they restrictive enough? Risk management considerations have become stronger, and the likelihood of rate hikes have strengthened of late.”
However, a looser jobs market could prevent officials on the nine-member MPC from backing a 25 basis point hike. Private sector wage growth is at lows not seen in nearly six years while the number of employees and vacancies both dropped over the summer, which could combine to weaken spiralling effects between wages and prices over the coming months.
ING economist James Smith said a continuation of the Middle East war blocking trade across the Gulf region, which would keep oil and gas prices higher for longer, could lead the Bank to warn against a wage-price spiral, often referred to as “second round effects”.
Smith said forecasts that suggest inflation could reach 4.5 per cent make the case for an interest rate hike stronger, although ING analysts believe that energy prices will dip later this year ahead of mid-term elections in the US.
On Wednesday, the Federal Reserve opted to raise rates in the US by 25 basis points to a target range of 3.75 per cent to four per cent, from a current level of 3.5 per cent to 3.75 per cent. Peel Hunt economist said it left the Bank out as an “awkward outlier” after the European Central Bank separately decided to raise interest rates last week.