The Bank of England Delivered a Historically Large Rate Hike, but Touted that Policy is “Not on a Pre-Set Path”

Aggressive Rate Hike

The Bank of England was one of the first major central banks to start it rate-hike cycle, with the December 2021 lift-off. Despite the early start, it has been traditionally cautious and had not resorted to moves larger than 25 basis points.

Today however, it broke with convention and raised interest rates by an aggressive 0.5% ^[1], which was the biggest hike since 1995 and the sixth straight move. Interest Rates now stand at 1.75%, to what is the highest level since December 2008.

The decision once again was not unanimous, as has been the case in all meetings of the year, since Ms Tenreyro dissented in favor of raising rates by a smaller 0.25%.

The outsized move did not come a surprise since governor Bailey had hinted towards such a possibility in mid-July, but the central bank has a poor track record in communicating its intentions and had misguided markets with the timing of its lift-off.

Higher Inflation & Recession Ahead

The central bank has been tightening due rampant inflation, which accelerated 9.4% in June (year-over-year) according to the latest CPI data, setting new four-decades highs. Officials don't see things getting better soon, since they upgraded their forecast today.

They now expect CPI inflation to hit a shocking 13% in the fourth quarter, and to "remain at very elevated levels throughout much of 2023". This is a marked upgrade, from the little over 11% peak, that was projected less than two month's ago.

The UK economy has been impacted by the fallout of the war in Ukraine, supply chain disruptions, Brexit complications and monetary tightening. The BoE believes that economy will slip into a recession from the next quarter and expects output to continue falling in every quarter until the end of 2023. It also anticipates real household post-tax income to to fall sharply in 2022 and 2023 and consumption growth to turn negative.

Hawkish Move, but No Pre-Set Tightening

Today's rate hike was massive and has not occurred for twenty-seven years, with officials reiterating their commitment to bringing inflation down, while repeating their pledge to "act forcefully", if required.

However, the Bank of England now stressed that "policy is not on a pre-set path", whereas Governor Bailey added that "all options are on the table for our September meeting and beyond that", during his press conference.^[2]

The updated rhetoric is less-hawkish than the previous one, as the impending recession places a higher bar on further tightening and the Bank of England may have lost a golden opportunity to front load its rate-hike cycle, before the economic downturn.

Less Aggressive CB Rhetoric

The Bank of England took a page out of its Australian counterpart's playbook with today's statement, since the RBA had used the exact same "not on a pre-set path" reference earlier in the week ^[3]. It also follows the Fed, which pivoted to a "meeting by meeting" and data-driven approach, instead of offering explicit guidance, contrary to what it had been doing up until recently.

Prospects of recession could make the continuation of tightening at the current aggressive pace difficult and the aforementioned central banks probably don't want to commit to a specific path. Chair Powell alluded to that, saying it "likely will become appropriate to slow the pace of increases". ^[4]

On the other hand, policy makers may find it hard to follow through on this softer rhetoric and slow the pace of rate hikes, if inflation does not begin to come down.

GBP/USD Reaction

The Bank of England may have delivered a super aggressive rate hike today, but the doom and gloom of the updated economic forecasts, along with the softened forward guidance, sent GBP/USD lower in the immediate aftermath.