Bank of England base rate decision

Commenting on today’s Bank of England base rate announcement, Chris Arcari, Head of Capital Markets, Hymans Robertson says:

"The Bank of England's (BoE) decision to leave the base rate unchanged today at 3.75% pa was broadly expected. While headline inflation rose to 3.1% in August, core inflation remained unchanged at 2.6% and wage growth eased to 3.9%, consistent with further loosening in labour market conditions and reducing the risk that higher energy prices trigger broader second-round inflation effects.

“Inflation remains above target across most major economies, while renewed tensions in the Middle East have pushed energy prices higher and reinforced expectations that policy rates may need to remain restrictive for longer. Although central banks would typically look through temporary supply shocks, underlying inflation remains elevated and economic activity has been more resilient than expected. While bond yields have fallen following today's announcement, the substantial rise in market yields over recent months has already contributed to tighter financial conditions and may partly reflect expectations that neutral interest rates are higher than before the pandemic. Together, these factors support a cautious approach to monetary easing across major economies.

“Further rate hikes cannot be ruled out, although the scope for additional tightening appears limited given already restrictive policy settings. We therefore doubt the Federal Reserve's recent rate increases mark the start of a prolonged global tightening cycle. The European Central Bank (ECB) has already raised rates twice this year, while the hurdle for renewed rate increases in the UK appears relatively high given weaker domestic growth conditions.

“Arguably the more important aspect of today's meeting concerns the pace of quantitative tightening (QT) over the coming year. By reducing the pace of active gilt sales to £20bn per annum, the Bank has materially slowed and smoothed the unwind process, reducing the amount of duration likely to be transferred directly to private investors and potentially easing some of the pressure on longer-dated gilts. At the time of writing, gilt yields had fallen following the announcement, with the largest moves occurring at longer maturities.

“With the Government's October Budget expected to increase gilt issuance, the interaction between BoE gilt sales and additional government borrowing has become increasingly relevant for investors. The Bank's decision to reduce active gilt sales to £20bn per annum should help alleviate concerns about gilt market supply, particularly as the Government is expected to increase issuance. Against this backdrop, while the outlook for policy rates remains finely balanced, we continue to believe markets may be pricing an overly restrictive path for UK monetary policy over the next 12 months."

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