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The Bank England remains dovish compared to the Federal Reserve, but how likely is that to change?

16 June 2022

UK interest rates went up by 25 basis points (bp) this morning: the fifth hike in a row.

By Matteo Anelli,

Reporter, Trustnet

At this morning’s monetary policy meeting, the Bank of England (BofE)’s committee voted 6-3 to raise interest rates by 0.25%. The decision, which took the new rate up to 1.25%, came one day after the US Federal Reserve (Fed) surprised the markets with a steeper increase than it had previously anticipated.

After the Fed set the pace with a last-minute decision to bump up the rate by 25 additional basis points (75 in total), UK investors were left unsure and split between the possibility of a 25bp or a 50bp increase.

Edward Park, Brooks Macdonald’s chief investment officer, said the market was perceiving the chance of getting one over the other as “a coin toss”.

By choosing the milder course of action, the BofE have been far more cautious than the Fed around the pace of economic growth within the UK, he went on to explain.

Indeed the UK’s economic performance disappointed the Bank’s positive forecasts and recorded a 0.3% contraction month-on-month in April, as Rob Clarry, investment strategist at Evelyn Partners, pointed out.

James Sproule, chief economist at Handelsbanken, justified the more dovish decision with the observations that the UK market is quicker at picking up changes.

“US consumers, with the vast majority of mortgages on long-term fixed rates, are naturally slower to respond to changes to interest rates than consumers in the UK where, while most mortgages are fixed, they are generally fixed for less than five years, sometimes as little as two years. The result is a much faster transmission of interest rate rises to impacting on consumer behaviour,” he said.

This argument did not convince Annabelle Williams, personal finance specialist at Nutmeg, who said that there is no guarantee of what impact these “textbook” measures will have and how quickly.

“The unusual economic environment we are in isn’t outlined in the textbook: two and a half years into a global pandemic with supplies of goods from overseas still held up; the impact of Brexit weighing on the economy, taxes rising and prices of assets such as property high after more than a decade of record-low interest rates,” she said.

Going forward, Jamie Niven, senior fund manager at Candriam, predicted the BoE would remain less aggressive than the Fed, despite the fact that “the 6-3 vote and full endorsement of guidance that they would ‘act forcefully in response’ to ‘more persistent inflationary pressures’ suggests the most dovish members have shifted at least somewhat since the last meeting”.

But tables might turn again in August, when the last one of the committee’s biggest hawks, Michael Saunders, is due to leave, as Oliver Blackbourn, portfolio manager at Janus Henderson, emphasised. “Predictions over voting will likely become more muddied after the next meeting”, he said.

Analysts both in the UK and the US expressed worries that the central banks’ monetary tightening does not write off recessionary risks.

In the UK, “we still see a recession as avoidable, but only just”, said Sproule.

In the US, commenting on the Fed’s decision, Richard Flynn, UK managing director at Charles Schwab, warned that 10 out of the previous 13 rate hike cycles have been associated with recessions.

Rate hikes often suppress economic demand, as individuals and businesses find it more expensive to borrow money to spend and invest.

Richard Carter, head of fixed interest research at Quilter Cheviot, noted investors are “understandably concerned” that such a sharp pace of monetary tightening will lead to a recession”, as markets are likely to remain volatile until we reach a peak in inflation.

He was in “no doubt the Fed got themselves behind the curve on inflation and are now having to make up for lost time”.

Not all agreed that the Fed and other central banks were behind the curve, however. Ronald Temple, co-head of multi-asset and head of us equity at Lazard Asset Management, said the decision sent exactly the right message to markets, with the central bank recognizing that hiking more now means less later. “The Fed nailed it,” he said.

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