The Bank of England raised interest rates to 4% today, the 10th consecutive hike since it began tightening in December 2021 but experts are starting to grow concerned that the central bank may not slow down in time.
This 0.5% increase since the Monetary Policy Committee’s last meeting in December last year takes the Base rate to its highest level in 14 years as it continues to try and slow inflation.
Efforts from the Bank to lower inflation have begun to show results, with the Office for National Statistics announcing the second consecutive month of declining inflation in December, but the 10.5% figure from last month is still far ahead of the Bank’s 2% target, albeit closer October’s peak of 11.1%.
Although markets priced in today’s hike, some investors may be disappointed that it was not shallower now that inflation has receded slightly, according to Rachel Winter, Partner at Killik & Co.
She said: “Many had hoped the Bank would hold off on a further rise given that our last inflation reading registered a small decline in prices. The good news is that we do appear to be getting close to peak interest rates.”
Indeed, Winter is among the numerous analysts who predict the Bank will raise interest rates to a peak of 4.5% this summer before bringing them back down to normal levels.
Others are not so sure - Andrew Aldridge, partner at Deepbridge Capital, said that the future direction of monetary policy appears hazy.
“Peak interest rates for the year remain unclear, creating a challenging environment for investors and financial advisors,” he said.
“It is important that businesses are not hamstrung by a lack of direction and have as much foresight to plan for the year ahead.”
Headline inflation may have fallen, but so is the UK economy’s growth prospects. The International Monetary Fund predicted that the UK will be the only major economy to shrink in 2023 and sharp interest rate hikes could exacerbate the damage, according to Karen Ward, chief market strategist EMEA at JP Morgan.
She said that this makes today’s 50 basis point rise appear “puzzling” given the already weakened economy, but the Bank may have to make further “unpopular choices” if it wants to take inflation fully under control.
With roughly half a million people out of the workforce since the pandemic, further hikes to “at least” 4.5% will be necessary, even at the detriment of the economy.
Ward added: “The problem is that the UK’s ability to supply goods and services appears to be suffering more acutely than our demand for those goods and services.
“This supply problem is most visible in the labour market. Vacancies have moderated slightly but still far outstrip the number of unemployed, and wage growth is climbing.”
Indeed, the Bank must tread carefully or else it risks plunging the UK into a difficult recession, according to James McManus, chief investment officer at Nutmeg.
He said: “This is the great balancing act that the Bank of England has to master – normalising interest rates at a pace the economy can handle, without going too far, too fast.”
Nicholas Ware, manager of the Janus Henderson Fixed Interest Monthly Income fund, said that the UK could be in for the hardest landings of any previous recession this year thanks to the Bank’s steep rise in rates.
The Bank of England’s 50 basis point rise was double that of the Federal Reserve’s. Last night the US central bank made its smallest rate hike of this cycle, bringing interest rates within the range of 4.5% to 4.75%.
Jerome Powell hinted that the 25 basis point increase will not be the bank’s last, with a “couple more hikes” implied over the coming months.
Further tightening could be a concern to some, but Robert Dishner, multi sector fixed income manager at Neuberger Berman, said that ongoing hikes are reasonable and are likely to remain shallower.
He added: “People are arguing it is hawkish as the Fed kept in language about ongoing rate hikes, but what else was it going to do? It wants to keep optionality open.”
Even if the central bank pushes rates further, tighter monetary policy has already dragged inflation down to 6.5% in December from its 9.1% high in June.
Willem Sels, global chief investment officer, HSBC, said: “The Fed knows that its inflation fight is showing some success and that it does not need to hike much more from here.”
Inflation may well be on the decline, but a tight labour market in the US remains a barrier for price easing, according to Nick Chatters manager at Aegon Asset Management.
Despite the hiking cycle that started in March last year, unemployment remains low, at 3.5% in December last year.
Chatters said: “The price falls we have been seeing in the goods sector cannot be translated across into the services sector without some easing in the labor market.
“Goods price declines are a function of supply chains opening up; however, labor costs are a significant input into services prices.”