Bank of England Still Hiking next Month?

BoE chief throws oil on the fire

Governor Bailey rebooted the aggressive move in interest rate markets by saying on Sunday that the bank will have to act in order to keep a lid on inflationary pressures. He went on to say that he was worried about medium-term inflation expectations, and this was taken as a warning for imminent tightening of monetary policy.

Comments like this from a central bank chief, backing up previous ones, are pretty explicit, especially with markets already having started to price in early rate hikes. The reaction on Monday was therefore swift with traders pricing in a rise to 0.25% at its meeting on November 3, with the chance of more tightening to follow before the end of the year. In fact, markets predicted a move to 0.5% by February and 1% by August, with a total of 115 basis points for the coming year.

This huge move essentially meant interest rates will rise faster than at any point in the post-crisis years. They also implied that inflation is more of a problem in the UK than across the pond in the US.

Market overreaction

Interestingly, Governor Bailey did also warn that monetary policy cannot solve supply side problems. He believes that higher inflation will prove temporary due to the nature of the underlying causes. Other MPC members, Mann and Tenreyro, only last week also suggested that there was little rush to raise rates.

In turn, UK CP figures came in weaker than expected on Wednesday, with a 0.3% month-on-month rise in September, against expectations of a 0.4% gain, pushing the year-on-year rate of inflation down to 2.9% from 3% in August.

Policy error?

We note that alot of UK inflation is primarily due to global issues which Bailey quite rightly says can’t be influenced by monetary policy. Indeed, the measure of domestically generated inflation preferred by the MPC matches its longer-term average. Inflation expectations also haven’t noticeably risen, and the risk of sharp wage growth is low.

Money markets have moderated somewhat with around a 70% chance of a 10-basis point rate hike in a few weeks. Hikes priced further out have also been wound in. Of course, this tightening of policy may come on top of fiscal tightening in the form of tax rises, plus the consumer will be hit by higher energy prices. No wonder GBP hasn’t moved decisively higher this week, as the growth challenges facing the UK increase through the winter months.

Written on 21/10/2021 by Lukman Otunuga, Senior Research Analyst at FXTM

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