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Bank of England Hikes Interest Rate to 4.5%, Commits to Curbing Inflation

The Bank of England increased its key interest rate by 0.25% to reach 4.5% in an attempt to control the rapid Inflation experienced by the U.K. Governor Andrew Bailey affirmed the central bank's commitment to "stay the course" as it works to manage the highest inflation rate among major economies.

Bank of England
Bank of England

Improved Growth Projections, Slower Inflation Decline

The BoE anticipates a slower decline in Inflation, primarily due to unanticipated surges in food prices and stronger wage growth than previously expected. However, the central bank is no longer predicting a recession, having significantly improved growth projections since it began publishing forecasts in 1997.

"Stay the Course" on Inflation, No Signals on Next Moves

Bailey emphasized the importance of staying the course to ensure. Inflation fell back to the 2% target while clarifying that the BoE was not signaling its next steps, which would depend on data. The Monetary Policy Committee members voted 7-2 for the May increase, in line with economists' expectations in the Reuters poll.

Investors Anticipate More Rate Increases

Investors are speculating on further rate increases, with a peak of nearly 5% expected this autumn. The BoE maintained its message from earlier this year, stating that additional tightening in monetary policy would be required if evidence of persistent pressures emerged.

Pound Gains, Bond Yields Rise and Settle

Following the rate hike announcement, the pound gained almost half a cent against the U.S. dollar, while British government bond yields rose before settling back to their pre-announcement levels. Some experts, such as Capital Economics' Paul Dales, believe rates have peaked and could remain at this level until 2024 before being cut.

Inflation Data to Influence Market Volatility

Upcoming inflation data releases, beginning with April's figures on May 24, could cause market volatility, particularly around currency, with the pound pricing in more aggressive action from the BoE than other central banks.

BoE's History of Rate Increases and Inflation Challenges

The BoE was the first major central bank to start raising borrowing costs in December 2021 but faced criticism for not acting aggressively enough as Inflation approached a four-decade high of 11.1% in October. Britain's high inflation problem is mainly due to its reliance on imported natural gas for power generation, making it especially vulnerable to energy price surges following Russia's invasion of Ukraine last year.

Inflation Predicted to Slowly Decline, Food Prices Impact Forecast

The BoE expects inflation to drop to 5.1% by year-end, down from 10.1% in March, but this is a smaller decline than the previously forecasted drop to 3.9%. The central bank predicts Inflation will not return to its 2% target until early 2025, with higher food price forecasts contributing about one percentage point to future Inflation compared to February.

Concerns Over Pay Growth Pressures

The BoE is concerned that recent strong headline pay growth could become a long-lasting economic issue. It now forecasts stronger wage growth and lower unemployment than three months ago, with pay rates potentially plateauing above those consistent with the 2% inflation target sustainably in the medium term.

Economic Growth Forecast and Government Stimulus

The BoE expects the U.K. economy to grow by 0.25% this year, an improvement from the 0.5% contraction predicted in February. The government's budget announced in March is anticipated to boost economic output by around 0.5% over the coming years, with cheaper energy, fiscal stimulus, and increased business and consumer confidence leading the BoE to no longer predict a recession this year. The central bank now expects the economy to be 2.25% larger in three years than previously estimated.

Impact of Past Interest Rate Hikes on Households and Businesses

The BoE estimates that roughly one-third of past interest rate hikes have affected households and businesses. The pass-through of these hikes has been slower in recent tightening cycles due to a higher share of homeowners with fixed-rate mortgages.

Debate on the Impact of Previous Rate Hikes

Bailey acknowledged that the extent of the impact on the economy from the BoE's previous rate hikes had been a "lively subject of debate" among Monetary Policy Committee members. The central bank will continue to monitor economic data and adjust its policy as needed to maintain stability and reach its inflation target.