BOE Hike Leaves Bailey on Brink of Fastest Tightening Since 1997

(Bloomberg) -- The Bank of England is on the cusp of the fastest tightening of monetary policy since it gained independence in 1997 as it leads the way among major central banks in fighting inflation.

The central bank delivered its second consecutive interest-rate increase and warned more moves are on the way. Policy makers are alarmed inflation is set to top 7%, more than triple their target and over a full percentage point higher than they forecast in December.

Some officials wanted to go even further, prompting markets to bet that the central bank will raise borrowing costs at each of the next three meetings as well as one more before the end of the year. That would bring the key rate from 0.5% now to 1.5%.

The size and speed of the total increase would be unprecedented -- and will add to an already tightening squeeze on consumer finances.

The overall impact will be even greater as the BOE begins unwinding the 895 billion pound ($1.2 trillion) of assets it built up over the past decade in its so-called quantitative easing stimulus program. Officials have already outlined plans to offload more than 220 billion pounds of government and corporate bonds by the end of 2025, and that program is likely to accelerate once rates pass 1%.

“There is likely to be a sharper rate-hiking cycle as they play catch-up to current inflation dynamics and try and retain credibility in relation to their inflation mandate,” said Georgina Taylor, a multi-asset fund manager at Invesco. “However, they may have to stop hiking very quickly or risk a policy mistake by putting the brakes on the economy too fast and too quickly.”

Economists also rushed to change their calls for further action. Deustche Bank now expects further back-to-back hikes at the next two meetings. Bank Of America Merrill Lynch expects rates will hit 1% in May.

The BOE in the vanguard of a global push-back from central banks against accelerating price gains. Inflation took off as economies reopened after the pandemic and have gathered pace as energy prices surge.

The BOE warned that consumer prices will probably rise as much as 7.25% in April as fuel and tax bills jump. That will squeeze down the value of what people earn by the most since 2011 and weigh on both growth and employment.

“The message from today is that weak growth is not enough to prevent the BOE from tightening further,” Allan Monks, an economist at JPMorgan in London, wrote in a note that called the central bank “inflation vigilantes.”

What Bloomberg Economics Says...
“The BOE's urgency, combined with a split vote and a signal of further moves in coming months, suggests hikes are now likely in March and May, with the risk of a further move in August. But the dovish forecasts in the medium term imply market expectations for rates to reach 1.5% by year end look wide of the mark.”
-- Dan Hanson. Click here for the full REACT.

Still, while the table seems set for an aggressive series of hikes, Governor Andrew Bailey cautioned against thinking “rates are now on an inevitable long march upwards.”

He noted that the beyond the short-term, the BOE is largely in thrall to developments in energy markets. Continued elevated prices could prompt faster action, and a rapid drop off could take the heat out of the hiking cycle.

For now, the BOE's own forecasts suggest markets are overly-aggressive. The BOE currently forecasts inflation will be a little above target in two years' time and drop below target in three years. The projection is based on interest rates reaching 1.5% by the middle of next year, a far shallower path than currently priced in.

An alternative scenario, based on energy prices following their futures curve, rather than remaining constant after six months, would lead to inflation dropping to around 0.75 points below target in two and three years' time. Both sets of forecasts suggest markets have gone too far.

“It's likely that we will raise rates again,” Bailey said in a Bloomberg TV interview on Thursday. “But please when I say that, don't over-interpret that. We will see inflation come off and we will see growth start to weaken. There's a lot of uncertainty around.”