Will the Bank of England hike interest rates?

The Bank of England is expected to hike base rate by 25 basis points tomorrow to 4.5 per cent which would be a 11th consecutive rise in its ongoing battle against inflation

The Bank is expected to follow in the footsteps of the US Federal Reserve and European Central Bank, which last week hiked their respective bank rates to 5.25 and 3.25 per cent.

However, Thursday could mark the last time in this cycle the Monetary Policy Committee follows the Fed’s direction with markets expecting the BoE to continue increasing the rate while its US peers takes a pause.

Rate rise: The Bank of England is expected to hike the base rate by 25 basis points on Thursday to 4.5%

UK consumer price inflation stood at 10.1 per cent in the 12 months to March 2023, down from 10.4 per cent in February, a step in the right direction but well above the BoE’s target of 2 per cent.

Meanwhile the labour market also remains stubbornly tight, with the BoE continuing to raise concerns about the impact of wage hikes on the underlying rate of inflation.

Katharine Neiss, chief European economist at PGIM Fixed Income, said: ‘The market is pretty much locked-in to the view that the BoE will follow the Fed and EBC and raise its policy rate a further 25bps at its next meeting.’

Neiss added that while the Fed has indicated it will now pause rate hikes and the ECB has suggested it has further to go, she expects the BoE to be more neutral on next steps.

She said: ‘A neutral stance would effectively buy the BoE some time to see whether interest rate rises to date are sufficient to cool the economy and bring inflation back to target, or whether further tightening is still needed.’

Feeding expectations of a hike on Thursday, UK economic performance, while weak, has been better than expected.

While some fear further hikes could tip the economy into recession, recent data showing stubbornly high inflation a tight labour market have driven expectations the BoE will continue hiking into late this year.

Swaps markets suggest almost two further hikes this year, with the potential for the base rate to peak at 5 per cent before the BoE then begins to cut.

Market pricing suggests the BoE will keep hiking before cutting rates at the end of the year

Head of macro unconstrained at Allianz Global Investors Mike Riddell said that while ‘cracks are spreading through the US labour market’, UK wage growth over the last three months has averaged an annualised rate of 6.6 per cent, higher even than UK core inflation’.

He added: ‘This poses a real problem for the BoE. If the BoE is correct and long-term annual productivity growth of the UK economy is now only around 1 per cent, then we think that hitting a 2 per cent inflation target would mean nominal wage growth in the UK needs to be less than half the rate it is now, otherwise inflation will continue to overshoot.

‘The BoE [also] can’t point to many signs of a sharp deceleration in growth that would give them confidence that inflation will fall back to target over the next year or two.

‘The BoE therefore needs to tighten policy further, and we’ll likely need more than another 25bps hike in this cycle.’

But analysts at ING think the market has priced the outlook for UK interest rates incorrectly, noting the BoE’s ‘recent emphasis on the lagged impact of past tightening suggests the bar for subsequent moves remains high’.

In a report earlier this week, ING said: ‘Unless there’s some really unwelcome economic news over the next few weeks, we expect a pause in June.

‘Since February, the Bank has been warning that past rate hikes are still largely to feed through to the economy. Further tightening, it said, was contingent on signs of ‘more persistent’ inflationary pressures.

‘It’s true that headline CPI is almost a full percentage point higher than the BoE predicted in February. But… that’s solely down to more aggressive food price rises, as well as some surprising stickiness in core goods inflation.

‘Neither trend is likely to be long-lasting, and services inflation, which tends to be much less volatile and more ‘persistent’, has come in bang on where the BoE had predicted. We think it’s pretty close to a peak.’

ING think this will be the last BoE hike with much of current price pressures temporary