The Bank of England raised interest rates to the highest level since the 2009 financial crisis and warned that the economy was on track to contract under double-digit inflation pressure. The 0.75% to 1% increase was supported by six of the bank's nine policymakers, and three voted for a 50 basis point move. Members who voted for a 50 bps increase are more cautious about inflation and worried about increased wage growth. Two members seem to have backed out from guidance that further increases should be made. The bank predicts that the UK will avoid a technical recession, with production falling close to 1% in the last quarter of this year due to tightening living standards. Annual GDP is expected to contract by 0.25% in 2023.

If we look at the highlights from the BOE statement;

Inflation is expected to rise above 10% in October due to another nearly 40% increase in the UK's energy price cap. (Russia's invasion of Ukraine)

Wage growth will rise to 5.75% in 2022, sharply higher than the February outlook, before falling over the next two years.

Unemployment is falling this year before climbing to 5.5% by 2025.

Households are facing a 1.75% decline in real disposable income this year, the second largest since 1964.

The economy continues to stagnate in 2024, with growth at a weak 0.25%. (Inflation and problems in the supply chain)

Most members agreed that some degree of further monetary tightening may still be appropriate in the coming months.

The Bank of England has made its fourth consecutive rate hike in May as it tries to balance rising inflation against the risk of recession. The Fed increased interest rates by 50 basis points, posting its biggest increase since 2000, signaling that it will continue to walk at that pace in the next few meetings. Despite the Fed's BOE decision, which came a day after the rate hike, the central bank is likely to become more cautious about the risk of recession. Some suggested risks are more balanced, and even this redirect is very strong. In March, the committee as a whole decided that "a more modest tightening of monetary policy may be appropriate". For now, however, the BOE is not alone in pursuing an aggressive tightening path.

 

BOE inflation forecast path display… Source: Bloomberg, Bank of England

Bailey said policymakers are walking a "very tight line" between fighting inflation and avoiding a recession. The BOE added that the war in Ukraine was the last of "massive successive shocks" to shake the economy. Forecasts, based on a market curve showing interest rates reaching 2.5% by mid-2023, showed inflation falling to 1.3% in three years, the biggest downside loss on the forecast horizon since the financial crisis. What this means is that current pricing has gone too far. A projection based on rates remaining at 1% has an inflation rate of just 2.16% at the same point.

Officials also said they would consider starting the process of actively selling bonds purchased under quantitative easing, a milestone for the policy that began more than a decade ago. No major central bank has yet actively sold government bonds. Corporate bond sales will begin in September. The baseline scenario is for policymakers to pause as activity data deteriorates. The risk is that higher inflation readings in the coming months will raise enough concern that rates will continue to rise in the second half. Thus, it causes developed countries to face the toughest balancing act at policy-making thresholds. As a result; Although it contains hawkish details as some members still defend 50 bps in interest rate hikes, future economic contraction/recession reservations soften the dosage of the statement and give way to the guidance that the Central Bank will follow a cautious course.

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