Bank of England to raise rates and start selling assets

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(Bloomberg) – The Bank of England is expected to raise interest rates on Thursday and begin selling off assets built up during a decade-long stimulus program, a historic tightening of monetary policy aimed at tackling the inflation.

Economists expect Britain’s central bank to raise its key rate by half a percentage point to 2.25% and confirm its intention to sell more of the £895 billion of bonds acquired under the quantitative easing program. Investors see a strong chance of a three-quarter point increase.

Officials led by Governor Andrew Bailey said they would act “forcefully” to prevent inflation from creeping into expectations that wage prices will continue to rise. This month’s decision, expected at midday London time, also gives the government an opportunity to recalibrate the BOE’s focus.

Here are the things to look out for in the decision:

Interest rate

A half-point rate hike would repeat the magnitude of last month’s increase, which was the largest in 27 years. Back-to-back hikes of this magnitude have not been seen since Black Wednesday 30 years ago, and those were reversed in the day.

A 75 basis point increase next week would be the biggest since 1989, when inflation soared after a consumer boom.

A drop in the value of the pound and soaring interest rates in the United States, the European Union, Switzerland and Sweden are pushing the BOE to accelerate the pace of tightening. The darkening of the economic outlook, which the BOE expects to tip into recession from the fourth quarter, amplifies the calls for caution.

Chancellor’s Letter

With inflation nearly five times above the 2% target, the BOE governor is required to write a letter to the Treasury outlining his plan of action. Chancellor of the Exchequer Kwasi Kwarteng’s response gives the government an opportunity to adjust its guidelines on how the BOE should act.

The letter, which is due on or shortly after the day of the BOE’s decision, is very likely to reiterate the Treasury’s earlier remarks that it is “imperative to bring inflation down.”

There may also be hints of the government’s ‘aim for growth’ strategy or a statement Kwarteng will make on Friday outlining fiscal plans to rescue consumers from soaring energy prices, an act that is expected to curb inflation. . And the Treasury could choose the letter as a way to signal details on how it will honor the government’s vow to review the BOE’s mandate.

Vote split

This month’s decision is complicated by changes to the BOE’s nine-member monetary policy committee. Last time out, he voted 8 to 1 for a 50 basis point raise, with Archdove Silvana Tenreyro voting alone for a smaller raise.

Since then Michael Saunders, one of the more hawkish members of the panel, has resigned and been replaced by Swati Dhingra, whose views on rates are not well known. Economists expect a three-way split, with seven policymakers voting for 50 basis points, Catherine Mann seeking 75 and Tenreyro again opting for 25.

What Bloomberg Economics says…

“We expect policymakers to vote 7-1-1 for a rate hike to 2.25% from 1.75%. Silvana Tenreyro is likely to prefer a 25 basis point hike, while Catherine Mann is expected to vote for a 75 basis point hike. Markets fully priced a 50 basis point move, with chances of a bigger upside at 75%.

–Dan Hanson, Bloomberg Economics. Click for PREVIEW.

Quantitative tightening

The BOE had planned to approve what is called quantitative tightening, where bonds in the asset portfolio will be sold. Prime Minister Liz Truss’ decision to borrow huge sums to avoid a winter spike in energy costs has introduced an element of doubt.

Bailey and chief economist Huw Pill said QT would not happen during market turbulence, and the pound and UK government bonds have fallen lately. BNP Paribas doubts that QT will go as planned this month.

Inflation outlook

The BOE predicted in August that inflation would peak at over 13% this fall, driven by rising energy prices. Since then, Truss has announced its intention to protect consumers from skyrocketing natural gas and electricity costs, and some economists are beginning to estimate that inflation could peak below that level – and certainly well below the 22% that Goldman Sachs had warned about before the government acted. .

This month’s decision won’t have a formal forecast for inflation and gross domestic product, but officials will likely include a number indicating where prices are peaking. Hints on how long inflation will stay above target will also help shape investor sentiment on the need to keep rates high, with many seeing the policy rate above 4% by now. mid-2023.

Recession risk

Truss’ energy package will also boost the economy, softening the blow that the BOE says will push the economy into recession.

This month’s officials might give a hint as to what impact the Truss package will have on those numbers. It won’t be until after the decision on Friday that the government will provide more details on the cost of the package.

Read more:

  • Traders bet the BOE will join the Fed with two giant hikes by the end of the year
  • Bank of England weighs biggest interest rate hike in 33 years
  • Truss’ plan to ‘turbo-charge’ the UK economy is already alarming the markets

©2022 Bloomberg LP

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