The Bank of England has caught markets off guard with its 7-2 vote to keep interest rates on hold at 0.1% even as it raises its inflation expectations to a peak 5%.
Following the midday announcement sterling fell to a four-week low of $1.356 against the US dollar. Markets had been pricing in a 58% chance of a rate hike ahead of the decision.
The monetary policy committee (MPC) voted unanimously to keep corporate bond purchases at £20bn, but there were three dissenting votes in its decision to continue with its existing programme of UK government bond purchases. At the September meeting, two members of the MPC voted for the central bank to cut its purchases from £895bn to £860bn. In August, the vote was 8-1 in favour of no change.
The Bank of England noted that due to supply chain disruption global and UK GDP had grown at a slower pace than projected in its August report. The BoE noted there were some signs of weaker UK consumption demand, and projected GDP to get back to its 2019 Q4 level in 2022 Q1.
Bank of England now expects inflation to peak at 5%
Last month chancellor Rishi Sunak wrote to governor Andrew Bailey to reaffirm the Bank of England’s remit to achieve low and stable inflation as the UK budget and spending review revealed prices were forecast to rise 4% next year.
But the BoE forecasts now expect that figure to be even higher.
It expects inflation to rise to just under 4% in October, predominantly due to the impact of utility bills. Further increases in core goods and food price inflation will see it rise to 4.5% in November where it will remain for the winter before peaking at 5% April. It is then forecast to fall back “materially” in the second half of next year.
UK inflation unexpectedly dipped to 3.1% in September after leaping 1.2 percentage points to 3.2% in August. Restaurants and hotels accounted for the largest downward contribution at 0.34%, down from 0.65% in August as the effects of last year’s Eat Out to Help Out scheme dropped out of the annual calculation.
The MPC said it will “always focus on the medium-term prospects for inflation, including medium-term inflation expectations, rather than factors that are likely to be transient”. The MPC continues to expect “some modest tightening” to be necessary to meet the 2% inflation target sustainably in the medium term. “Nevertheless, near-term uncertainties remain, especially around the outlook for the labour market, and the extent to which domestic cost and price pressures persist into the medium term,” the MPC said.
US Federal Reserves to trigger tapering
The Bank of England decision comes a day after the US Federal Reserve announced it was this month launching its widely signalled $15bn a month tapering plan. It is expected to run until June 2022 although the Fed stated it is prepared to change the pace of monthly reductions if economic conditions warrant.
Inflation was described as transitory in the statement from the Federal Open Market Committee meeting.
