As Bailey insists, interest rates won’t rise as far as feared…the Bank is dropping the pound again
- The pound plunged yesterday as the governor of the Bank of England poured cold water on interest rate expectations
- Sterling fell around 2 pc. towards $1.11, as Andrew Bailey said the markets were wrong in believing yields would peak to 5.25 pc next year.
- His comments came as the Bank raised interest rates by a whopping 0.75 percentage point to 3 percent, the largest increase in more than 30 years.
The pound plunged yesterday as the governor of the Bank of England poured cold water on interest rate expectations.
Sterling fell about 2 percent towards $1.11 as Andrew Bailey said the markets were wrong in believing yields would peak to 5.25 percent next year.
His comments came as the Bank raised interest rates by a whopping 0.75 percentage point to 3 percent, the largest increase in more than 30 years. But in a warning to traders expecting more bumper hikes, Bailey suggested the unprecedented rate of rate hikes would soon slow down.
The pound plunged yesterday as the governor of the Bank of England poured cold water on interest rate expectations
He said: “We can’t make any promises about future interest rates, but based on where we are now, we think bank rates will need to rise less than is currently priced in the financial markets.”
Since December last year, the Bank has raised interest rates from their record low of 0.1 percent in an attempt to cool off the red-hot inflation. Higher rates should put pressure on prices by encouraging saving rather than spending, but they also increase the cost of mortgages and other debt and curb economic growth.
In the latest report from its nine-member Monetary Policy Committee (MPC), the Bank said raising interest rates to 5.25 percent would delay the recession — which it said began in the third quarter of this year — for two years.
Unemployment, meanwhile, is expected to nearly double to 6.5 percent. However, the Bank presented an alternative scenario, in which the interest rate remained at the current level of 3 percent. It said this would be enough to push inflation back from its 40-year high of 10.1 percent to its target of 2 percent over the next two years.
Inflation would then fall below 1 percent after three years. In more normal times, that could indicate that the bank was almost done with rate hikes given its mandate to hit a 2 percent inflation target.
The Rebels Who Voted Against the Huge Walk
More splits arose at the Bank of England when two members of the rate-setting Monetary Policy Committee (MPC) opposed the increase to 3 percent. Swati Dhingra called for an interest rate hike of 0.5 percentage point to 2.75 percent and Silvana Tenreyro voted for an increase of just 0.25 percentage point to 2.5 percent. They were voted out by the other seven members, who opted for a 0.75 percentage point increase. The split exposed the Bank’s difficulty in guiding Britain through the economic storm. Dhingra said “a small rate hike was warranted to avoid a deeper and longer recession” in Britain. Tenreyro, meanwhile, said the interest rate hikes already observed would bring inflation below 2 percent in due course.
Supported Small Rise: Swati Dhingra
Kallum Pickering, an economist at Berenberg, said the Bank “may need to do much, much less than the market expects in terms of further rate hikes to bring inflation back to its 2 percent target.”
Bailey’s decision to enter the markets caused the pound to plummet. This was just the latest example of the bank’s governor clashing with investors. At the end of 2021, when inflation had already started to pick up, the Bank failed to raise interest rates as expected.
The lack of action led to accusations that Bailey had “bottled” it, as traders had interpreted his earlier comments as a sign that a rate hike had been implemented.
The pound fell more than 2 percent. Yesterday’s clash with traders again dragged the value of sterling lower, which would normally rise on news of higher rates as traders switch to a currency that promises higher returns. It is now at its lowest point since Kwasi Kwarteng was sacked in mid-October after a disastrous six-week stint as chancellor.
The pound has also been dragged down by the US Federal Reserve, which has been more aggressive than the Bank in its fight against inflation. The Fed has raised interest rates by the unusually high amount of 0.75 percentage points in the last four meetings, pushing the base rate between 3.75 and 4 percent, and traders flocking to the dollar. While the Bank of England said its own base rate was unlikely to reach 5.25 percent, it admitted it was also unlikely to stay at 3 percent.
Bailey said, “Where the truth lies between the two, we don’t advise on that.”
Analysts said Threadneedle Street would be concerned about other unpleasant surprises, especially with regard to gas prices, which have been a major driver of rising prices.
Philip Shaw, an economist at Investec, said rate setters also had no idea what Chancellor Jeremy Hunt would announce in his fall statement later this month, and whether there might be more household help that could fuel inflation.