The Bank of England predicted raising interest rates for the second time in quick succession

The Bank of England is widely expected by economists and financial markets to introduce the first back-to-back rate hikes since 2004 when it meets to decide monetary policy this week.

With the central bank struggling with fierce inflation, BoE officials have not tried to quell speculation ahead of Thursday’s monetary policy committee meeting that a rate hike is almost a security after the rise from 0.1 percent to 0.25 percent approved by the MPC in December. It was the first rate hike in more than three years.

In the money markets, the probability of an interest rate rise this week is 0.5 per cent. priced at almost 90 per cent, and the majority of economists agree.

They are convinced that the bank will have to act because it has failed to predict the extent and breadth of price increases, below which consumer price inflation reached a 30-year high of 5.4 per cent in December.

Economists also believe that the BoE has underestimated the strength of the labor market, with vacancies almost matching the number of unemployed for the first time since consistent records began more than 20 years ago.

Line chart of CPI inflation with successive BoE 2021 forecasts (%) showing that the BoE has not been able to predict the rise in inflation

Liz Martins, an economist at HSBC, said that data since the BoE raised interest rates in December required action to tighten monetary policy, as she also noted that the threat from the Omicron coronavirus variant seemed to disappear.

“In the fourth quarter of last year, the MPC experienced the biggest inflation forecast error ever,” she said. “The biggest source of uncertainty in December, the Omicron variant, appears to be on the way back, with Plan B restrictions [in England] now promised. ”

Anna Titareva, an economist at UBS, points to the same reasons why the BoE should raise interest rates: “There will probably be a strong majority in [MPC]or even unanimity, in favor of a hike. “

BoE officials have said very little ahead of the MPC vote on Thursday, but when they have spoken, they have sounded hawkish. Bank director Andrew Bailey acknowledged last week that energy prices could remain high for a long time, keeping inflation well above the central bank’s target of 2 percent well into 2023.

Catherine Mann, an external MPC member, said this month that corporate expectations of price and wage growth were not in line with that goal, and monetary policy was needed to “dampen” those impressions.

The latest Citi / YouGov survey of public inflation expectations shows that people are more pessimistic about price growth in the coming year than at any time since 2006.

Line chart of the number of vacancies per  Vacancies showing labor market conditions in the UK are particularly tight

The BoE said last year that if interest rates rise to 0.5 per cent, “it intends to start reducing the stock of purchased assets”, a reference to the £ 895bn. of gilts and corporate bonds that the central bank has bought since the financial crisis under its quantitative easing program to stimulate the economy.

It could reduce the stock and shrink its swell balance by not reinvesting money in additional assets when bonds expire, but this is not an automatic move where MPC promises in August to begin the process of quantitative easing “if relevant given the economic circumstances ”.

This suggests that MPC’s nine members will have two votes on Thursday: one on interest rates and another on buying assets.

Most economists believe the MPC will vote to start shrinking the BoE’s balance sheet, although Bailey told MPs last week that he expected any quantitative easing to be delivered this way “not [to] have the great influence ”.

George Buckley, an economist at Nomura, predicted that the BoE would stop the reinvestment of money from expired assets, even though there was a large 28 billion. GBP maturity for the guilds in March.

He said that if the economic conditions “were appropriate for an interest rate increase of 0.25 percentage points, they would also be for passive sales [of assets]”.

Amid consensus that MPC is tightening monetary policy on Thursday, economists disagree on the number of rate hikes likely this year and what level will be reached.

Financial markets have priced four quarter-point gains in 2022, with rates of nearly 1.5 percent in the spring of 2023.

Line chart of OIS market interest rate expectation (%) showing that financial markets now believe that UK interest rates will rise faster

Ruth Gregory, an economist at Capital Economics, shared this hawkish stance, saying that MPC could very well abandon existing guidance that it will only impose “modest” interest rate hikes over the next few years.

“Inflation has risen much higher and much faster than the Bank of England’s forecast, and the past month has brought further evidence that price pressures are expanding,” she added.

But the majority of economists believe that the BoE will be more measured by its rate hikes in hopes of shocking people into believing that it is serious about bringing inflation down without having to prescribe the painful medicine with significantly higher borrowing costs to limit the costs.

Cathal Kennedy, an economist at RBC Capital Markets, said the BoE could raise interest rates slowly because the combination of this and quantitative easing would send a strong message.

The BoE will outline its view of future interest rate hikes in its forecasts on Thursday, based on market expectations for monetary policy.

If these show that inflation is expected to fall to less than 2 per cent in the medium term, it will signal the bank’s perception that the financial markets have become too enthusiastic by assuming four quarter-point interest rate hikes in 2022.

But if the BoE forecasts show inflation higher than 2 percent in 2024-25, it would signal a radical shift in the BoE towards sustained interest rate rises and its intention to defeat the most difficult inflation episode since the early 1990s.

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