- A 25bps rise in Bank Rate left the official interest rate at 1%, the highest since January 2009. The MPC now forecasts inflation to peak at 10% later this year and GDP is expected to fall by almost 1% in Q4 2022, pushing calendar-year growth in 2023 into negative territory. However, the EY ITEM Club thinks the MPC’s forecast is too pessimistic.
- The MPC’s significant forecast downgrades and the cost of living pressures already facing households suggests it will take a cautious approach to future tightening. The EY ITEM Club expects only one further rate rise this year. With sterling weakening immediately following the MPC’s announcement, markets appear to be shifting towards our more dovish view.
Martin Beck, chief economic advisor to the EY ITEM Club, says: “Another MPC meeting, another rise in interest rates. The 25bps increase announced today took Bank Rate to 1%, a level not exceeded since 2009. The MPC’s vote was split, with three members voting for a bigger, 50bps, rise.
“Policy was tightened despite a significantly downgraded growth forecast. GDP is now expected to fall by nearly 1% in Q4 2022 and calendar-year growth is forecast at -0.25% in 2023, down from the +1.25% predicted in February. While the MPC is not expecting a technical recession (two successive quarters of negative growth), it does see the economy contracting in two of the four quarters from Q4 2022 to Q4 2023. Moreover, with inflation surprising to the upside in recent months, the MPC expects the CPI measure to now peak at 10% later this year.
“The EY ITEM Club thinks the economy is unlikely to perform as poorly as the MPC expects. For one, the committee’s projections are conditioned on market expectations for interest rates which look too aggressive. Investors expect Bank Rate to reach 2.5% by Q2 2023, a level which would mean inflation, in the MPC’s view, significantly undershooting the 2% inflation target over the medium term and a significant amount of spare capacity opening up. Meanwhile, the recent fall in wholesale gas prices (which are currently closest to the lowest since last summer) and the likelihood of more government support to households in this Autumn’s Budget point to a smaller rise in energy bills later this year than expected, keeping inflation from reaching the double-digit rate expected by the MPC. And the strength of household and corporate balance sheets, with households and non-financial companies sitting on over £300bn of ‘excess’ savings accumulated during the pandemic, may offer greater scope to mitigate cost of living pressures than the MPC is allowing for.
“May’s policy statement said that “most” members felt more tightening would be needed in the coming months. But the committee’s gloomy expectations for GDP growth and cost of living pressures already facing households suggest it will take a cautious approach to future tightening. And the possibility that the near-term inflation outlook may prove to be less bad than expected could also rein back the committee’s hawks. The EY ITEM Club expects only one further rate rise this year. With sterling weakening immediately following the MPC’s announcement, markets appear to be shifting towards our more dovish view.
“Meanwhile, the MPC had said last summer that Bank Rate reaching 1% would be the threshold at which it would consider selling some of the £875bn of gilts purchased under the QE programme. With that threshold now met, the MPC said that Bank staff would work on a strategy for gilt sales, with an update to come in August. With financial conditions having tightened significantly in recent weeks (for example, the 10-year gilt yield recently exceeded 2% for the first time since 2015), and the step into the unknown “active” quantitative tightening would represent, this seems a sensible approach given the headwinds the economy already faces.”