The Bank of England (BoE) embarked on another interest rate hike yesterday by 50 basis points, marking its highest rate increase since 1995. The forex market is absorbing the shock of this slightly aggressive interest rate hike embarked upon by the BoE on Thursday.
Monetary policy committee members voted almost unanimously to embark on a 50 basis points hike for the British pound, bringing the interest rate from the old position of 1.25% to the new level of 1.75%. This could be seen as the most significant single rate increase in 27 years.
Only one committee member had voted for a lower rate hike by just 25 basis points. While other committee members supported the rate of 50 basis points – Silvana Tenreyro was a lone voice calling for a repetition of the previous 25 basis points hike applied in June.
Speaking on the reason for embarking on this decision, the MPC cited the rising inflation rate as the primary reason behind their decision. In their remarks, the wholesale gas prices have almost doubled since May. Food and commodity costs had risen significantly also.
Their position is understandable as the British consumer price index hit a 40-year high of 9.4% in June, which is already more than four times the committee’s target of 2%. Therefore an aggressive interest rate hike was necessary to help tame the rising inflation.
The committee hinted so much about the country’s possible recession. Inflation is expected to peak at 13.3% in October. It is presumed to remain at these levels until 2023 before falling to its target of 2% in 2025.
Committee’s Predictions on Recession
The MPC predicted that the country will likely fall into a recession from the fourth quarter of 2022, expected to last for five quarters. This means the government will battle a recession throughout 2023 and 2024. The recession predicted by the committee would be similar to the slump seen in the 1990s but far different from the hit by COVID-19 and the downturn in economic growth caused by the 2008 – 2009 global financial crisis.
Highlighting more the nature of the recession to expect, the MPC said they expect the economy would begin to shrink in the final quarter of 2022 and then contract throughout 2023. This will mark the most prolonged recession ever after the global financial crisis.
Nonetheless, the committee stated that there were “substantial” uncertainties currently surrounding the economy – which could make the slowdown more or less severe than its significant forecasts. They believed this would further determine their following line of action regarding the interest rate. In their descriptions, “Policy is not on a pre-set path,”. Hence, they concluded that:
“The scale, pace, and timing of any further changes in Bank Rate will reflect the Committee’s assessment of the economic outlook and inflationary pressures.”
Impact of the Labour Market
The monetary policy committee had considered the labour market capable of containing the recent interest rate hike and possible future rate hikes. In their submissions, the labour market remains tight and strong enough to withstand the recent rate hikes, notwithstanding the high pressure from domestic and energy costs.
This could be seen in the unemployment rate remaining low at 3.8% for the past three months. After its September meeting, the BoE also revealed that it will be expected to sell down its massive stockpile of government bonds – currently worth 844 billion pounds -. Here it hopes for an active sales of around 10 billion pounds per quarter.
Market Reaction to the news of a 50 basis point hike for Pounds
There has been no strong market reaction to the news so far as. This is because the 50-basis-point increase had been long predicted and awaited by investors as inevitable. Some traders already took buy positions earlier, pending the outcome of the meeting today. This category of traders was forced to take profits when the rate hike came out at just 50 points.
GBPUSD had not risen so much after this based on the fact that the 50 basis points, though marking the first aggressive interest rate hike for the Pounds, does not match the two consecutive 75 bps hike for the US dollar embarked on by the Fed. This is why investors had considered this move slightly dovish.
A 75 basis was necessary to give the pounds more strength in the market.
Nonetheless, we still expect the pounds to strengthen a little with this news on a short-term basis.
What impact will the current interest rate hike have on GPBUSD and GBPJPY?
The current interest rate hike by 50 basis points is expected to strengthen the pound against other currency pairs matched with it in the market, at least for the short term.
GBPUSD was currently recovering again after the initial selloff yesterday. The considerable selloff resulted from poor enthusiasm by the bulls on just 50 basis points only when the US Fed had continuously hiked the dollar by 75 basis points. However, GBPUSD is expected to recover gradually this month. The same holds for GBPJPY, recovering after a massive selloff yesterday.
Conclusion
With the inflation rate expected to continue rising for the rest of 2022 and peak at 13%, it is now challenging for the bank to support the economy without continuing with more aggressive interest rate hikes. Hence, investors are expected to brace up and wait for more interest rate hikes during the committee’s subsequent sessions. With inflation currently sitting at 9.4% in June, a more aggressive interest rate hike becomes inevitable.
Some investors are currently predicting 25-basis-points hiking during the committee’s next meeting in September. However, the subsequent rate will depend on the outcome of the inflation report for July.
