Bank of England signals terminal rate fast approaching

Today’s monetary policy decision from the Bank of England (BoE) duly delivered the 25bps increase widely expected by the market. But the take-away message is that, while a further modest tightening in monetary policy can be expected, the peak level of interest rates may be nearer than has been anticipated: the cost of this lower terminal rate will be interest rates being kept at a higher level, for longer.

The new inflation forecasts provided by the BoE’s Monetary Policy Committee (MPC) today have largely endorsed market expectations that just one more 25bps increase in interest rates can probably be expected going forward. Indeed, the minutes of today’s meeting described the current policy stance as already “restrictive" but retained the message that a “further tightening in monetary policy would be required” if evidence of more persistent pricing pressures than assumed in its inflation forecasts emerged. However, in a key change, the MPC added that it “will ensure that Bank Rate is sufficiently restrictive for sufficiently long to return inflation to the 2% target sustainably in the medium term”, ie monetary policy is set to remain tight. Overall, these two aspects have been interpreted by the market as a signal that we are closer to peak interest rates than previously considered, but that the cost of this lower terminal rate will be monetary policy remaining at a more restrictive level for longer than previously envisaged. Current projections for the UK’s terminal rate have fallen by around 15bps following the meeting, with a rate of approximately 5.65% now anticipated.

As we have seen in the past, the MPC was again split on which direction to take monetary policy in, with a single vote for no change and two votes for a 50bps increase being made alongside the six votes for a 25bps rise. This split does leave a sense that the MPC itself is uncertain over what to do, and that it is similarly uncertain of how much of a risk the UK economy is of being tipped into a recession through its monetary tightening. An element of confusion was similarly sown by the somewhat mixed messaging delivered today. On the one hand the market was told that further tightening will be delivered “if” there is evidence of persistent pricing pressures, suggesting a dovish tilt in the language. But at the same time, the inflation profile has been revised upwards from May’s forecast, while the MPC alluded to “persistent pricing pressures now starting to crystalise” with the message that rates will be kept “sufficiently restrictive for sufficiently long.” It is difficult to describe an upwardly revised inflation profile and description of monetary policy as "restrictive" as anything other hawkish. With the large UK fiscal deficit rendering the government largely redundant in being able to steer the economy via tax policy, the market would have been hoping for a coherent and clear message from the BoE over the role monetary policy will play. Unfortunately, it probably did not get the degree of clarity it was seeking.

Overall, the take-away message from today’s meeting is that we appear closer to the BoE being comfortable in pausing its tightening agenda. But there is still some uncertainty surrounding this and the cost of any earlier pause will be interest rates remaining elevated for longer than previously expected. This will be bad news for mortgage holders and borrowers in general, as it suggests that they face an extended period of raised interest payments. And it is a message that will not be welcomed by the government either as, tied by fiscal constraints preventing any tax cuts ahead of the next general election, it implies there will be no relief provided to voters by the BoE either. Accordingly, the overall winner from today is probably the opposition Labour Party, who will be seeing the UK's economic travails as providing a ticket into power.