By Michiel Willems
The Bank of England’s decision to further raise interest rates from 1.25 per cent to 1.75 per cent and its two-year predictions means bad news for investors and UK residents alike.
And the pain is far from over. A top City analyst expects this to further rise to 2.25 per cent in September.
Other than adjusting the interest rates to the accurate level to keep abreast of import inflation, the economic projections for the UK paint a bleak outlook for the next two years.
The Bank explained that the rise in interest rates was necessary due to external pressures which are expected to persist.
This means that British firms and residents will continue to feel this weight reflected in rising domestic prices, wages outpaced by soaring inflation, and even higher mortgage repayments, despite the Bank’s attempt to widen the borrowing pool through less restrictive mortgage rules.
Although historic, the Bank’s decision was not a surprise for Michael Hewson, Chief Market Analyst at CMC Market, a London-headquartered financial services company, who believe the Bank was expected to raise interest rates higher than 1.25 per cent during the June meeting, as a means to keep import inflation in check.
This is on the backdrop of a 10 per cent year-to-date depreciation of the British pound sterling against the US dollar and an indication from the Federal Reserve, the US central bank, of a further interest rate increase by 0.5 per cent or 0.75 per cent in September.
The value of the euro against the British pound sterling is set to remain under pressure, whereas the ‘cable’ GBP/USD forex pair is likely to maintain the current uptrend.
Meanwhile, the yield on a 10-year government bond, or gilt, fell by 0.09 per cent to 1.83 per cent.
Hewson noted that “it has sent the pound sharply lower across the board, with the potential to test key support levels at 1.1980 against the US dollar and 0.8480 against the euro.”
“The Thursday announcement from the Bank of England has all the signs of a dovish reaction.”
Hewson explained what this means for the City and UK investors: “The UK currently fares worse than both the EU and the US.”
“This is due to its closer dependence on energy shocks than the States and less government intervention to soften the blow compared to its European counterparts. Government bonds in all three markets all rose in prices on Thursday.”
Recession later this year
The UK is projected to enter a recession in the final quarter of this year, the Bank of England announced.
The country’s economy will contract by 1.25 per cent in 2023 and 0.25 per cent in 2024, however, inflation is becoming a much bigger long-term threat, with unrealistic chances of falling back to the desired 2 per cent much before 2024.
Hewson stressed that the current political race for the Conservative Party leadership and the consequent fiscal policies promoted by the new British government is “a major factor to take into account” for any inflation, GDP, and unemployment projections and investment decisions.
As it stands with the current measures, inflation is expected to peak at 13.3 per cent in October, he pointed out.
“This a sharper increase than the Bank expected in June, originally estimated at 11 per cent. It will continue to rise throughout 2023 only to decline in 2024,” Hewson noted.
Inflation
Meanwhile, forecasts for the Consumer Price Index (CPI) are less optimistic now, expected to decrease only to 9.5 per cent in the third quarter of 2023, although the Bank anticipates a sharp fall in prices immediately thereafter.
“Selling prices are set to increase to reflect rising costs while real household post-tax income is expected to plunge in 2022 and 2023,” Hewson said.
Core prices will peak at 6.5 per cent this year, meaning that, in the following six months, food and energy will constitute more than half of the headline CPI.
Unemployment is expected to rise to 6.3 per cent in 2025, standing at 3.8 per cent in the three months to May 2022, and rising to 5.5 per cent in 2023.
The Bank of England suggested that it plans to unwind its holding of gilts, next month, to the tune of £10bn per month. The next meeting for the Monetary Policy Committee is set for September 15.
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