To combat stubborn inflation, the Bank of England on Thursday (May 11) duly raised interest rates by 25 basis points, lifting its main interest rate by 0.25 percentage points to 4.5%, the 12th consecutive increase since December 2021.
The Bank of England also warned that it would continue to raise interest rates if inflationary pressures persist, saying that "if there is evidence of persistent pressures, then further monetary policy tightening will be required."
Luke Bartholomew, senior economist at investment firm Abrdn, said the Bank of England's decision to raise interest rates by 25 basis points to 4.50 percent will mark the end of the current cycle of monetary tightening. However, he said the risks were heavily tilted towards a rate hike and inflation would need to behave more normally in the coming months if policy was indeed to remain on hold at this level. The Bank of England made a sharp upward revision to its forecasts for economic growth. Bartholomew believes the monetary tightening already in the pipeline, combined with a sharp slowdown in the US, will see the UK economy experience recession-like conditions for much of this year.
Commerzbank believes that the Bank of England's second rate hike leaves the door open for further rate hikes, but this will depend on the persistence of inflation, and unlike the Fed, the Bank of England has not given any clear indication of a pause. Commerzbank does not expect the Bank of England to raise rates further, but ultimately it will depend on the data. However, the fact that the statement did not attempt to dispel speculation of further rate hikes suggests that the risk of at least one more hike is high.
Hussain Mehdi, macro and investment strategist at HSBC Asset Management in the UK, said in a note that a "policy-induced recession" was almost inevitable as the Bank of England had to raise interest rates to counter the risk of a "trickier than expected" potential inflation and wage-price spiral. He expects Bank of England rates to peak at 5.0% by August, with a cut unlikely until 2024. With interest rates moving further into restrictive ranges and credit conditions tightening, a policy-induced recession is almost inevitable. HSBC is cautious on risk assets in the UK and Europe as markets reflect "relatively optimistic macroeconomic and corporate earnings outlook expectations".
What is the outlook for sterling?
Ed Hutchings, analyst at Aviva Investors, believes there is a risk that sterling will fall in the medium term as the Bank of England has to aggressively reverse its rate hike cycle. After the Bank of England raised interest rates by 25 basis points to 4.5 per cent, markets are pricing in at least another 25 basis point increase, so it may take a while for the Bank to pause. With growth forecasts upgraded, a recession may be avoided in the near term. However, the more the boe raises rates, the bigger and faster it is likely to cut them, hitting the pound.
British financial services firm Hargreaves Lansdown said the pound remains weak, which could spell trouble for the Bank of England. While the pound has strengthened considerably since the disastrous days brought to an end by the Truss government in September, it remains very weak compared to where it was trading before the Brexit vote. That adds to the Bank of England's inflation headache, as the weak pound pushes up the cost of imported goods, pushing up consumer prices.
Alex Livingstone, head of trading at Titan Asset Management, said sterling could quickly reverse its recent gains against the dollar if underlying risk aversion drives investors to safety. Expectations of further Bank of England rate hikes have recently pushed sterling above 1.26 against the dollar as interest rate differentials between the U.S. and U.K. have narrowed. However, it may not be plain sailing for sterling in the coming months as several key risks remain, including the US debt ceiling impasse and a worsening US banking crisis. The realization of either of these two major risks would weaken risk sentiment and thus boost the dollar, Livingstone said.
Ebury, a financial services firm, sees room for the pound to rise. Because the Bank of England said Thursday it would raise interest rates further, and the U.K. appears increasingly confident of avoiding a recession as it raises its growth forecast for 2023. The Bank of England is likely to raise interest rates further if inflation persists, a clear signal that there will be at least one more hike in June and possibly one more in August. This is a clear bullish signal for the pound, especially as both the Fed and the ECB have abandoned their interest rate guidance.
