The Bank of England has tempered expectations of future rate hikes, with inflation expected to fall next year, but only as Britain faces its longest recession in at least a century.

By raising the key rate by 75 basis points to 3 percent, the BoE’s Monetary Policy Committee predicted that inflation would fall from its current 40-year high of 10.1 percent by 2024, “slightly below” the 2 percent target.

The bank rate, as the base rate is officially known, is now expected to peak at around 4.5 to 4.75 percent instead of 5.25 percent or higher, as was recently expected.

While inflation is expected to remain above 10 percent ‘in the short term’, energy prices are expected to fall sharply, removing significant price pressures from the picture.

Inflation expected to fall sharply from mid-next year by the Bank of England

The Bank of England warned of a recession in August and has now emphasized that the downturn will be longer and more painful.

Nevertheless, policymakers today hiked key interest rates by the largest amount in 30 years, following the US Federal Reserve’s hike of 0.75 percentage point last night.

However, expectations have eased with regard to the future interest rate path and the Bank has indicated that inflation is expected to decline rapidly from next year.

The BoE wants to prevent an impending recession from worsening through excessive increases, with GDP now contracting next year and into the second half of 2024.

The UK economy is expected to slide into recession if GDP growth turns negative

The dark blue band in this fan chart shows the Bank’s most likely path in its GDP forecast, with growth declining over an extended period

How high will interest rates peak?

Educated market economist at ING James Smith said the BoE’s most recent policy statement and forecasts “are a clear signal that bank rates are unlikely to rise as far as investors expect in the coming months.”

He added: “The BoE today was faced with a choice between a 50bps ‘hawkish’ rate hike and a 75bps ‘dovish’ – and in the event it chose the latter path. Unlike the Fed and the European Central Bank, this is the first time in this cycle that the BoE has risen 75 basis points.

“But there are no good options for the Bank, and the central message from its latest communication is clear: investors expect too much tightening at future meetings. We think today’s 75bp move will likely be a one-off.”

According to the bank’s latest forecasts, the economy would shrink by about 3 percentage points over time if it raised interest rates as high as 5 percent, as the markets had predicted until recently.

Markets now expect the BoE’s walking cycle to peak at 4.5 percent.

But, Smith warned, “The Bank of England predicts a deep recession, whether or not it deepens further.”

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The Bank of England report was based on market forecasts for interest rates on Oct. 25, but boss Andrew Bailey noted that expectations had fallen since then – key interest rates are now expected to peak below instead of above 5 percent.

Bank of England Governor Andrew Bailey has announced that interest rates will not peak as high as the market currently predicts

What could bring inflation down?

Behind the BoE’s latest forecasts are “high energy prices and significantly tighter financial conditions” weighing on spending.

With regard to energy costs, however, the MPC said it had seen indications that these kinds of “external factors” “will exert less upward pressure on UK inflation over the next three years” compared to the August forecast.

It said: ‘Energy prices are expected to have less of an impact on inflation over the next six months, thanks to the Energy Price Guarantee for Households and the Energy Bill Relief for Businesses.

“Some non-energy commodity prices have fallen from recent peaks and there is also evidence that bottlenecks in global supply chains are beginning to ease.”

Inflation is expected to fall below the 2% target and remain there in the dark orange most likely pad band in the Bank of England chart

‘External’ factors influencing inflation have fallen back

But the “domestic factors” that influence inflation, such as a historically tight labor market, have intensified, the BoE added, warning that these factors could be “more persistent” than external ones.

The BoE said: “Overall, the MPC expects inflation to remain above 10 percent in 2022 Q4 and 2023 Q1 before falling back.

“Given the high path of market interest rates, CPI inflation is falling sharply and is below the medium-term target of 2 percent, although the MPC believes the risks to the inflation projections are upwards.”

Nicholas Hyett, investment analyst at Wealth Club, said: ‘Overall, the economic picture is probably better now than a month ago after the mini-budget turbulence.

“The bank may feel that it can step up a bit in the future as interest rates rise more slowly and end lower than we might have thought a few weeks ago.

“It’s too early to take time for rate hikes, but from here on the rises could be slower – reflected in the fact that two committee members voted to raise rates by less than 75 basis points this time around.

‘It helps that the government and the bank are now moving in the right direction. The Bank raises rates to curb inflation by discouraging people from spending. Rishi Sunak’s plans to raise taxes and cut government spending are having the same effect. The recent stability of sterling reduces the need to raise interest rates to also defend the currency.”

The Bank of England has published forecasts, but the Bank Rate figures are based on market expectations for the week to October 25. Forecasts have since been relaxed.

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