Bank of England set to raise interest rates to 4%

interest rates LONDON, ENGLAND - MAY 05: Andrew Bailey, Governor of the Bank of England, addresses the media on the Monetary Policy Report at the Bank of England on May 5, 2022 in London, England. The Bank of England has raised interest rates to their highest level in 13 years in an effort to tackle the cost of living crisis gripping the UK. (Photo by Frank Augstein - WPA Pool/Getty Images)
Andrew Bailey, governor of the Bank of England, will explain the Bank of England's decision on interest rates. Photo: Frank Augstein/WPA Pool/Getty Images

The Bank of England (BoE) is expected to increase interest rates for the tenth consecutive time this Thursday in another blow to mortgage holders.

Markets expect a 0.5 percentage point increase in the central bank’s base rate to 4%, its highest level since the 2008 financial crisis.

“As wage growth and core inflation have continued to surprise to the upside, we expect another +50bp [basis point] hike on Thursday, in line with market pricing,” Peder Beck-Friis, portfolio manager at PIMCO, said.

This would be the BoE’s tenth interest rate rise in a row, since it started tightening policy in December 2021, adding to the pressure on homeowners.

The Bank of England has raised UK interest rates to their highest level for 14 years (Yahoo News UK/Flourish)
The Bank of England has raised UK interest rates to their highest level for 14 years. Chart: Yahoo News UK/Flourish

Interest rates to hit their highest levels since the financial crisis

Matthew Ryan, head of market strategy at Ebury, predicts a 50bp hike due to a lack of clear evidence of a downward trend in inflation.

“Since the December meeting, we think that macroeconomic news out of the UK has mixed ramifications for monetary policy though, on balance, we are pencilling in another 50bp rate increase this week,” he said.

“The focus among committee members clearly remains on inflation and, as of yet, we are yet to clear evidence of a downward trend in either the headline or core CPI measures.”

Forecasting group The EY Item Club predicts that the BoE will deliver better economic news along with the 50bp rise.

Read more: Mortgage costs expected to rise this year, says Bank of England

“A significant fall in gas prices, lower market interest rate expectations and an economy less weak than expected should cause the Bank of England to dial back on the downbeat economic outlook of its last forecast when it presents new projections on Thursday,” it said.

“Stubborn core inflation and strong pay growth mean another 50 basis points rise in bank rate is likely. But the EY ITEM Club thinks this increase could prove the end of the current rate-rising cycle.”

Deutsche Bank’s (DB) senior economist Sanja Ray also sees interest rates hitting 4% this Thursday.

“Will they meet market pricing of 50bp, or surprise and downshift to 25bp? Our long-standing view has been that the MPC will deliver one more 50bp hike in February before downshifting to more 'normal' sized hikes in March and May, taking bank rate to a peak of 4.5%,” he said.

The half a percentage point hike by the BoE would raise interest rates to their highest levels since autumn 2008 when Lehman Brothers filed for bankruptcy and kickstarted the great financial crisis.

How certain is a 50 basis points hike?

The level of the increase, however, is still shrouded in some level of uncertainty as some traders recall the lack of unanimity in the last meeting.

“As for the BoE, a 0.5% rise to 4.0% also looks likely although is rather less certain given the marked disagreement at the last MPC [Monetary Policy Committee] meeting on whether to raise rates or leave them unchanged,” Rupert Thompson, chief economist at Kingswood, cautioned.

The MPC split three ways in December, with two members – Silvana Tenreyro and Swati Dhingra – voting to end rate increases, while Catherine Mann backed a larger 0.75 percentage point move.

Investec Economics also expects a smaller rate hike that would take it to 3.75% on Thursday, before peaking at 4% in March.

“Recent weeks have ushered in a greater sense of economic optimism,” Philip Shaw, chief economist at Investec, said.

“This has been driven partly by the mild European winter, which has helped to avoid a need for energy rationing, contributing to a substantial fall in current spot gas prices as well as gas price futures.

More misery to UK households

Threadneedle Street is trying to walk a very fine line. It does not want to push the UK into a recession by raising borrowing costs but its mandate is to keep inflation at around 2%.

The rate of inflation eased to 10.5% but remains close to a 40-year high as UK households continue to be squeezed by the cost of living crisis. Businesses are being crushed by struggling to find affordable credit.

"Weaker growth and the large exposure of the UK economy to the housing market mean the Bank of England may be reluctant to aggressively raise rates at this time," said Frédérique Carrier, head of investment strategy for RBC Wealth Management in the British Isles and Asia.

"The consensus peak rate of 4.4% might not be reached. Consequently, higher inflation is likely to linger for longer."

While inflation is now falling thanks to softening energy prices, there are fears that persistent strong wage growth could still keep it well above the BoE’s 2% target.

The Bank’s former chief economist has warned that the BoE must slowdown interest rate rises to avoid undermining the UK’s recovery.

Andy Haldane told the BBC Radio 4’s Today programme last week: “I’d have preferred the Bank and other central banks to have started their rate rises a bit sooner.

"That would have helped a bit in nipping inflation in the bud and would have meant that we wouldn’t have had those rapid rate rises at the same time as the economy was hitting the buffers.”

He added: “I fear there is more pain to come as those mortgage rate rises from last year begin to hit people’s bank accounts over the course of this year.”

Read more: Bailey: Chaos from Truss's budget 'gone' but market confidence still fragile

More than 1.4 million UK households are due to renew their fixed-rate mortgages in 2023, the Office for National Statistics said in January.

How much higher will interest rates go?

Economists polled by Reuters say there is a glimmer of hope in the economy’s long-term future as interest rates appear to be reaching their peak.

Analysts are expecting one more rate rise – to 4.25% in March – while financial markets think that the tightening cycle will end in the middle of this year at 4.5%.

Paul Hollingsworth, chief European economist for Europe at the French bank BNP Paribas, said: “We still believe that the end of the tightening cycle is nearing.

"Soon, we expect the MPC to shift from increasing rates to emphasising that rates will need to stay at elevated levels for a long time in order to bring down underlying inflation.”

Read more: UK mortgage approvals slump amid higher borrowing costs

In December 2021 the base rate stood at just 0.1% as the policymakers tried to encourage consumer spending after COVID slowed down the economy.

The US Federal Reserve and the European Central Bank (ECB) will also hold policy meetings this week. Investors expect the Fed to slow the pace of its monetary tightening to 0.25 percentage points, raising rates to the highest level since September 2007, the start of the global financial crisis.

The ECB is widely expected to lift rates by half a percentage point to their highest levels since autumn 2008 when Lehman Brothers filed for bankruptcy.

Watch: How does inflation affect interest rates?

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