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Are the BoE and government working together, or drifting apart?

23 September 2022

The Bank and the government appear to be at loggerheads, according to analysts.

By Jonathan Jones,

Editor, Trustnet

It appears as though the Bank of England and the new Conservative government are on a collision course of sorts, with both seemingly trying to fix different problems.

Yesterday, the UK central bank raised interest rates by 0.5 percentage points, a lower-than-expected hike but one that aims to keep inflation in check.

It is the seventh increase this year and has taken the base rate from 0.1% to 2.25%, representing a sharp increase in borrowing costs, on top of the painful rise in energy and food prices experienced by many already in 2022.

This is in stark contrast to the government. Later this morning, chancellor Kwasi Kwarteng is expected to make a raft of policies designed to help people with the cost-of-living crisis by freeing up cash.

Already confirmed is the national insurance hike reversal, which will boost take-home pay, but has a larger effect on higher earners.

According to Charles Stanley chief investment analyst Rob Morgan, a corporation tax rise will be shelved, while stamp duty may also be on the chopping block.

There are also potential VAT cuts, income tax threshold reviews and a look at the state pension triple lock are all also possible when the chancellor speaks at 9.30am.

It is expected that the package announced could cost as much as three times that of the furlough scheme introduced during the Covid-19 pandemic.

Susannah Streeter, senior investment and markets analyst at Hargreaves Lansdown, said the Bank and the government appear to be at loggerheads.

“Team Bailey at the Bank of England want to squeeze demand out of the economy, to try and stop the spiral of prices, while Team Truss want to stimulate it, risking prolonging the pace of rate hikes,” she said.

She added that the Bank’s policymakers are “digging in their heels” but should brace for “the counterattack from the Treasury” today.

So why is this? It comes down to attacking two different problems. The Bank is chiefly concerned with double-digit inflation and wants to deal with it by squeezing out demand.

The government meanwhile seems determined to keep demand at higher levels by reducing tax and freeing up more cash in consumers’ pockets in an effort to fan the growth flames.

Vivek Paul, UK chief investment strategist for the BlackRock Investment Institute, said it is a “complicated” environment in which there will be more volatility and the UK’s “credibility” will be tested in markets.

So what can you buy? For long-term investors, the advice is typically to hold pat, but for those willing to try to time markets Hinesh Patel, portfolio manager at Quilter Investors, said that the Bank’s rate hike has now produced “one of the most prospectively attractive set-ups for fixed income assets in at least a decade”.

BlackRock’s Paul added that in this area he is overweight UK gilts as he does not believe that the Bank of England will “ultimately follow through with all the hikes priced into markets”.

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