In Recession and Uncertainty: The Bank of England Raises Interest Rate to a 30-Year High | Daily Market Analysis

In-Recession-and-Uncertainty:-The-Bank–of-England-Raises-Interest-Rate-to-a-30-Year-High

Key events:  

UK – Construction PMI (Oct)

Eurozone – ECB President Lagarde Speaks     

USA – Nonfarm Payrolls (Oct)  

USA – Unemployment Rate (Oct)  

Canada – Employment Change (Oct)

Canada – Ivey PMI (Oct)

 

Bank of England (BoE) aggressively raised its policy rate by 75 basis points to 3.00% in yesterday's monetary policy announcement.

Even so, the Bank of England also signaled that the pace of policy tightening is likely to slow down going forward. First, while all policymakers voted to raise interest rates, the size of the rate hike was not unanimous. The Bank of England also said that interest rates could peak at a lower level than was priced into the financial markets at the end of October (although at the time it was expected to peak at around 5.25%).

UK-interest-rate
UK interest rate

The central bank's updated economic forecasts give a clear indication of why interest rates may rise less quickly than before. Under the main scenario based on market interest rates, a prolonged recession and inflation will not reach the target level in the medium term. Even in a scenario in which interest rates remain at 3.00%, CPI inflation is projected to be only slightly above the target level in two years.

Given that the prospect of further fiscal consolidation may also have an impact on growth prospects, we forecast somewhat less policy tightening by the Bank of England than previously. Analysts expect a 50 basis point rate hike in December and a final 25 basis point hike next February. This will bring the rate to a peak of 3.75%.

The combination of a prolonged economic recession and a central bank that fails to meet market expectations for a rate hike are key factors driving our view that sterling will resume weakening in early 2023, with the GBP/USD rate target at $1.0600 by the end of the first quarter of next year.

GBP-USD-hourly-chart
GBP/USD hourly chart

At the same time, Cable was heavily depreciated in the foreign exchange market yesterday as fears of a prolonged recession caused the sterling to fall in favor of the FTSE100. While the FTSE100 is now protected by the positive impact of a weaker pound on corporate earnings, this rise is unlikely to last as traders estimate the longest recession since accounting began.

FTSE-hourly-chart
FTSE hourly chart

While banks have benefited from rising rates, the economic outlook looks far from favorable with a possible recession until mid-2024. Perhaps most worrisome is the fact that today's outlook is by no means a worst-case scenario: there is a distinct possibility that energy prices will jump again, leading to monetary tightening and a prolonged recession. Unfortunately, interest rates may seem like a relatively ineffective tool to combat the highest inflation caused by geopolitical factors and underinvestment.