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The Bank of England raised Bank Rate by half a percentage point for a second time in September but warned that it could “respond forcefully” to anything that threatens to lift inflation further and since then there have been significant government policy announcements, some of which may matter to the BoE.
Monetary Policy Committee (MPC) members at the BoE voted to lift Bank Rate from 1.75% to 2.25% on Thursday and acknowledged that financial markets saw risks of interest rates rising above 4% next year, although since then the outlook for UK infation has evolved. significantly.
This is after a budget-like announcement from Chancellor Kwasi Kwarteng on Friday that has lifted the government’s Net Financing Requirement (NFR) for 2022-23 by an estimated £72.4 billion, to just more than £234BN, through its inclusion of various public assistance. schemes and a large package of tax cuts.
Chancellor Kwarteng said the cost of the government’s Energy Price Gurantee and other energy-related measures alone “is expected to be around £60bn” for the first six months while also announcing a wave of tax cuts and reforms that can be measured in percentage points of GDP.
These will help to lessen or partially offset what the BoE has estimated will be a five-quarter long recession but by propping up domestic economic demand, the danger is that these measures also add to inflation and ultimately invite a more aggressive interest rate response from the bank in November.
So while the new measures may be supportive of the economy, they could also lead to even higher borrowing costs for the government going forward, which could have a range of other possible implications for the economy and even government policy during the years ahead.
With this, below is a selection of the latest remarks from analysts and economists covering in no particular order what Thursday’s policy decision and Friday’s government announcements could mean for Bank of England interest rate policy, the economy and financial markets going forward.
James Rossiter, head of global macro strategy, TD Securities
“The UK government revealed its mini-budget today, which was anything but mini. Spending commitments announced today range between £35b to £45b in each of the following four fiscal years. A largely-unexpected reduction in income taxes poses upside risks to the inflation outlook.”
“We now expect the BoE to hike 75bps in November, and continue hiking in 50bps increments in December and February. A final 25bps hike in March 2023 would leave the terminal Bank Rate at 4.25% over the remainder of 2023.”
“There is no doubt that the bearish momentum in Gilts is here to stay for now. This in particular holds as the Gilt market absorbs the additional issuance. We expect 10y Gilts to end 2022 at 3.5%.”
“With the UK proposing to blow up its budget deficit, a weakening balance of payments backdrop should keep downside pressure on the currency. Our year-end forecast of 1.11 for cable is now at risk of looking too high and we will not be surprised if calls for parity begin to emerge.”
Andrew Goodwin, chief UK economist, Oxford Economics
“Though the market reaction has been negative, we think it’s unlikely that the government’s approach will cause sterling to collapse or create problems in selling gilts. But the absence of a credible long-term economic and fiscal strategy does leave UK assets vulnerable, with sterling. the most obvious release valve.”
“Despite the likelihood of more aggressive monetary tightening, we expect sterling to continue to drift lower to around $1.05 in the short-term.”
“The BoE has been clear that it believes there is little or no spare capacity in the economy, and that it needs to rein in demand to get inflation under control. The minutes of the September meeting were clear that the scale of today’s package would be pivotal in determining the pace of future hikes in rates.”
“And with the package being towards the upper end of expectations, we think the BoE will react aggressively. We now expect a 75bps hike at November’s meeting and will raise our forecast for the peak in Bank Rate to 4%, from 3%.”
Charles Hepworth, investment director, GAM Investments
“Inflationary headwinds continue and with this tax cut giveaway potentially only adding to inflationary concerns, it makes the Bank of England’s job of cooling rising costs even harder. The good news is that the Bank at least retains its independence, for now.”
“Market reaction has been brutal: the additional debt borrowing required to implicitly fund the tax cuts has smashed gilt yields higher and prices much lower.”
“The 5 Year benchmark gilt yield registered an extreme outlier move, rising 45bps on the day of the announcement alone and down 6% over the month – already making it much more expensive for the government to fund its policies with all the new gilt issuance that will be required.”
“Kwarteng ripping up so much of the previous Chancellor’s plans is perhaps unsurprising, given the overall change in policy direction, but the political optics look alarming.”
“With just two years for this “growth spurt” to materialise and lift all boats, it’s the Conservative Party’s biggest gamble ahead of the next election.”
Jane Foley, head of FX strategy, Rabobank
“Even though the market is skeptical of the worth of the government’s new 2.5% growth target, the measures announced by the Chancellor this morning are unshamedly designed to boost demand. The obvious implication is that BoE rates are likely to be higher for longer than they would have been otherwise. While textbooks suggest that higher short-term interest rates should be currency supportive, GBP has been demonstrating since the spring that this is not always the case.”
“The UK is burdened with a record current account deficit/GDP ratio. A 2017 statement by former BoE Chief Carney that the UK is reliant of the kindness of strangers is a reference to the fact that GBP is vulnerable to a downward revision if foreign investors are reluctant to fund the deficit. Unusually today’s budget was not complimented by forecasts from the Office. of Budgetary Responsibility.”
“The pressures on the gilt market will have been accentuated by the confirmation from the BoE yesterday that it will press ahead with its planned gilt sales. These are set to add up to GBP 80 bln over the next 12 months. Despite the Chancellor’s reassurances this morning that the Treasury and the BoE continue to work in close concert. This is not a message that investors are necessary accepting.”
“Concerns over the UK’s fiscal position combined with its recessionary outlook and extremely high level of inflation leave the pound extremely vulnerable.”
“We retain a GBP/USD1.08 target for cable.”
Ross Walker and Imogen Bachra, chief UK economist and head of UK rates, Natwest Markets
“Although most of the measures had been well-trailed, the overall scale of the stimulus exceeded our expectations and triggered a sizeable rise in gilt yields (~25bp higher to 3¾% on 10yr, closing in fast on our pre-existing 4.0% target , which we revise up to 4.5%).”
“Sterling did not react well, continuing its descent towards $1.10 (one wonders if there is a feasible policy mix which would persuade FX markets to drive a rebound in the pound).”
“Reaganomics’ fiscal policy (deficit-financed tax cuts) seems likely to compel the BoE to do a more forceful impression of Paul Volcker.”
“Economists may debate the efficacy of individual fiscal policy measures – in terms of how well targeted they are, multiplier effects etc. What is beyond dispute is that this is a substantial fiscal stimulus and one which will clearly put additional pressure on the BoE to tighten. monetary policy.”
“The £72bn fiscal spur in the current year, with further easing beyond, prompts us to revise up our ‘terminal’ Bank Rate forecast to 4.0% (+75bp in November & December, with a final +25bp) rise in February.”
“The key takeaway from the UK Government’s ‘Growth Plan’ is hardly complicated: there will be a substantial, multi-year – indeed unprecedented – increase in gilt supply for private investors to absorb. The government have announced a pandemic-scaled fiscal stimulus, with gross gilt issuance this year topping £190bn and, in all likelihood, close to ~£250bn next year – but without the offsetting monetary policy stimulus (in the form of QE) to absorb all the additional issuance.”
“Taken together, these should add significant bearish pressures, particularly to the long-end of the curve, in the weeks to come. We revise up our 10yr gilt yield target to 4.5%, as the market re-prices for the deluge of supply. over the coming years with a lack of demand for duration and UK assets in particular.”