AJ Bell press comment – 2 February 2023
Laith Khalaf, head of investment analysis at AJ Bell, comments on the latest decision by the Bank of England to raise interest rates by 0.5%:
“The Bank of England has pulled no punches in the fight against inflation, and a strong labour market is the driving force behind the decision to plough on with tightening monetary policy. The market is now pricing in interest rates peaking at 4.5% in the middle of this year, and the Bank’s figures and commentary suggest that’s in line with their thinking. It’s notable that the two dovish members of the interest rate committee haven’t picked up any followers, with a strong caucus of seven maintaining a hawkish stance on interest rates.
“Alongside the interest rate hike, the Bank has also published a more benign forecast for UK economic growth this year, though things are still far from rosy, with the economy expected to be moving backwards until 2024. The forecast has been improved by lower energy prices, a strong labour market, and reduced expectations for interest rate rises compared to the last forecast in November, when the market was still digesting the aftermath of the mini-Budget. The big unknown in the UK’s economic forecasts is the toll higher interest rates will take on activity, and these are only just beginning to be felt in the real economy. The quandary the central bank always finds itself in is that it takes so long to see the effects of monetary policy that interest rate-setters are almost always destined to understeer or oversteer.
“The Bank is now projecting that inflation will fall to 4% by the end of the year, which will be music to the ears of the PM, who has promised a halving in the inflation rate - though the Bank might legitimately be a little peeved the government is trying to claim credit for their efforts. Inflation is now forecast to fall to 0.4% in 2026, which begs the question why the Bank is continuing to raise interest rates. The answer seems to be that the MPC is putting an awful lot of emphasis on the upside risks to their inflation forecast. A word cloud for this monetary policy report would probably highlight the phrase “persistent inflationary pressures”, a far cry from the transient inflation mantra of 2021. The Bank is clearly concerned that inflationary demands are becoming embedded in the domestic economy, and that even if external factors like high energy costs fall away, we may be left with a legacy of rising prices.
“For now then, it looks like the Bank is erring on the side of caution when it comes to inflation, but that comes with the risk of pressuring businesses and consumers more than is necessary. Assuming inflation falls back this year, the MPC is likely to face increasing calls to loosen monetary policy, and indeed longer term forecasts show base rate falling back. The good news is, the Bank is now in a much better position to stimulate the economy by cutting interest rates than it was when interest rates were close to zero.”
