The Bank of England (BoE) has maintained rates at 5.25%, the third consecutive month of standing pat with a six-to-three vote. The three dissenters all voted to raise rates by 0.25 percentage points.
It was more hawkish in its rhetoric than others such as the Federal Reserve, with three votes to raise rates. The dissenters argued “an increase in Bank Rate at this meeting was necessary to address the risks of more deeply embedded inflation persistence and to return inflation to target sustainably in the medium term”, according to the Monetary Policy Committee report.
Overall, the report said the MPC would “continue to monitor closely indications of persistent inflationary pressures and resilience in the economy as a whole”, noting that monetary policy would need to be “sufficiently restrictive for sufficiently long” to return inflation to the 2% target.
It also failed to rule out future rate hikes, noting that “further tightening in monetary policy would be required if there were evidence of more persistent inflationary pressures”.
Hetal Mehta, head of economic research at St James’s Place, said: “The Bank of England's decision today to maintain a hawkish message sets it markedly apart from the Fed. Underlying inflation is still uncomfortably high and the recent pricing of multiple rate cuts from early next year was clearly an easing of financial conditions that the BoE felt the need to push back against. The fall in wage inflation so far is not enough to be consistent with the 2% inflation target.”
However, market-implied projections suggest the MPC will keep rates flat until the third quarter of 2023, at which point they will reduce gradually to 4.25% by the end of 2026.
In this scenario, the Bank suggests GDP will remain broadly stable in the first half of the forecast, while inflation should return to the 2% target by the end of 2025.
Rob Morgan, chief investment analyst at Charles Stanley, said a key question for investors is when interest rates will start to fall?
“The BoE is conscious of going too far with raising rates and inflicting more pain than necessary on the economy, but ultimately its job is to bring inflation down to target. Just as squeezing the last bits of toothpaste out of the tube is more difficult, squeezing the remnants of unwanted inflation out of the system can be tricky, so it needs to maintain restrictive interest rates for a while longer,” he said.
“The problem is how much strain can the economy take without a severe slowdown? Although they are now moderating, higher interest rates and borrowing costs are having a progressively greater effect on consumer and business spending as more mortgages and loans roll off the cheaper short-term fixes secured in the prior era of lower rates."
It remains a tough environment for many households, according to Myron Jobson, senior personal finance analyst at interactive investor, who are “struggling to keep on top of the financial fallout from the run of 14 consecutive interest rate rises that stretched back to December 2021”.
The housing market could remain subdued, he suggested, as people wait to take out mortgages until rates have hit their lowest point, while savers should lock in rates soon to get the best deals ahead of yields dropping.
The Federal Reserve last night held rates again at its final meeting of the year, the third consecutive time it has opted not to make a change as inflation continues to head towards its 2% target.
Central banks around the world are contending with high inflation while trying not to stymy an already fragile economy – an issue the Fed is not immune from.
Whitney Watson, co-chief investment officer of fixed income and liquidity solutions for Goldman Sachs Asset Management, said: “The Fed will wrap up its year with a slight sense of satisfaction, as core PCE inflation has decreased from its peak of 6.6% to 4% without a major slowdown in the economy or sharp rise in unemployment.
“Strong growth and labour market indicators preclude an immediate shift to rate cuts. Should disinflation continue in the coming months, we would expect policy normalisation from next summer.”
She expects a 0.25 percentage point rate cut in June, which will start a slow and steady reduction to the policy rate, which she anticipates will end the year at 4.25-4.5%.
However, the Federal Reserve’s own median forecast for next year points to 0.75 percentage points of cuts, with core inflation forecast to fall to 2.4%. The S&P 500 rose more than 1% following the announcement.
Charles Hepworth, investment director at GAM Investments, said: “This was a more dovish projection than most expected ahead of the meeting and further acknowledgement that we are now firmly post peak rates.”
For consumers and investors, Rachel Winter, partner at Killik & Co, said it is a “positive sign” that we have “likely reached the peak of the interest cycle”.
“Interest rates on both sides of the pond are now expected to fall in 2024, and investors should start to think about how to best capitalise on this. Falling interest rate environments have historically been good news for both equities and bonds. More generally, a new year is a great time to review investment portfolios and make sure they have exposure to promising themes such as artificial intelligence and energy efficiency,” she said.