BoE sees growing case for rate rise as inflation outlook darkens

The Bank of England said the case for higher interest rates “appeared to have strengthened” on Thursday after it nudged up its forecast for inflation at the end of the year to over 4%, more than twice its target rate.
The BoE said it expected the overshoot to be temporary, but two policymakers called for an immediate halt to the British central bank’s £895bn ($1.23tn) bond purchase programme, which is due to run until year-end.
Sterling rose by almost a cent against the US dollar and two-year British government bond yields surged 9 basis to their highest since March 2020 as traders bet on an earlier rate rise by the BoE, which would be the first major central bank to hike since the Covid-19 pandemic.
After the decision, interest rate futures priced in a 90% chance that the BoE would raise rates by February, up from just over 60% before – though many economists say this is premature given the challenges to growth.
“It’s clear the committee is divided on how much of an issue rising inflation poses. Given the number of headwinds facing the economy this winter, we think a rate hike is unlikely until the second half of 2022,” ING economist James Smith said.
Surging energy prices and bottlenecks in supply chains are raising price pressures globally as Western economies emerge from the Covid-19 pandemic but have also squeezed growth.
The BoE said it had revised down its expectations for the level of gross domestic product in the third quarter by around 1% from the August report, reflecting supply constraints.
But it said inflation – which hit a nine-year peak of 3.2% last month – would “temporarily” rise above 4% in the final quarter of the year.
A jump in natural gas prices in recent weeks – which has led to the collapse of several smaller British energy suppliers and forced the government to intervene – meant inflation risked staying above 4% in the first half of 2022 too, the BoE said.
The nine-member MPC – including new members Huw Pill and Catherine Mann – voted unanimously to keep interest rates at 0.1%.
But deputy governor Dave Ramsden joined external MPC member Michael Saunders in voting to cap government bond purchases at £840bn pounds rather than using the full £875bn programme the BoE launched in November 2020 during the pandemic.
They saw “increasing evidence from a range of global and domestic cost and price indicators that inflationary pressures were likely to persist”, according to the BoE’s policy minutes.
But other MPC members were more cautious, especially as the government’s job furlough programme will end this month, with unclear implications for unemployment.
The benefits of waiting for more data were likely to outweigh the cost, they said – especially as tighter monetary policy would not reduce the immediate price pressures.
However, the BoE said the medium-term path for interest rates was up and policymakers did not rule out raising interest rates before the central bank completes its asset purchases.