Borrowing costs reached a 15-year peak today after the Bank of England opted to hike interest rates yet again, to the highest level in the G7.
It was the fourteenth consecutive hike from the BoE’s Monetary Policy Committee but, this time, it was accompanied by a new warning: expect borrowing costs to remain high for the foreseeable future.
The rise to 5.25 per cent is more modest than July’s dramatic rise from 4.5 per cent to 5 per cent – and unsurprisingly so: the MPC was contending with a less gloomy set of data compared to their last meeting. While UK inflation is still the highest in the G7, it did fall more than expected in June, to 7.9%, from 8.7% the month before.
Markets are now expecting interest rates to peak at 5.75 per cent in January – down from the 6.25 per cent they had forecast just a few weeks ago.
The PM will also be relieved to hear that the Bank is now predicting that inflation will drop below 5% in the final quarter of 2023 – meaning Sunak will meet his much-publicised target of halving inflation by the end of the year.
But it’s not all good news. While interest rates aren’t expected to peak as high as they were a few weeks ago, don’t expect them to dramatically fall any time soon.
“The MPC will ensure that Bank Rate is sufficiently restrictive for sufficiently long to return inflation to the 2 per cent target,” stated Andrew Bailey, the Bank’s governor, today. This is been interpreted as a warning that it’s time to start seeing 5 per cent interest rates as the new normal because they could last well into 2025.
The Bank also predicts that inflation won’t return to its 2 per cent target until mid-2025. And it’s pinning much of the blame on the fact that wage growth at the end of this year is expected to be 6 per cent, up from the BoE’s May forecast of 5 per cent. “Higher than expected” pay increases in recent months, particularly in the private sector, means there are still too many people with spare dosh to spend. Remember, rate hikes are intended to squeeze budgets in order to curb spending and, in turn, bring down prices.
While higher interest rates are the medicine intended to cure painfully high inflation, they do, of course, have their own painful side effects – for mortgage holders, renters, businesses and for the government too. Higher borrowing costs mean the government has to pay more interest on the country’s debt, making it more expensive to spend on things like schools and the NHS.
And, judging from Bailey’s new pledge to ensure the bank rate is “sufficiently restrictive” for enough time, it sounds as if this isn’t going to be a short burst of pain, but a long drawn out one.
Much of the pain of previous rates is yet to be felt. As Maggie Pagano wrote in Reaction yesterday, it can take as much as two years for higher rates to really bite.
Some economists say this means the Bank has been too hasty to raise rates yet again.
“It would have made more sense to pause to assess the impact of the large increases in rates that have already taken place, as other central banks have done,” says Julian Jessop, Reaction contributor and Economics Fellow at the IEA.
The Bank of England, he adds, is “still looking in the rear view mirror”.
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