Concern for UK economy and markets after BoE rate rise

The Bank of England’s decision to raise interest rates by 0.5 percentage points on 4 August was the largest hike seen since 1995 and took the base rate to 1.75%.

During the announcement, the central bank warned it expected the UK to enter a recession by the end of the year and inflation to reach 13% by the final quarter of 2022.

Citywire Selector has collated the views of leading portfolio managers and market commentators on what impact the decision might have on markets and the UK economy. They all raised concerns.

Too slow to act

Gordon Shannon, a bond manager at TwentyFour Asset Management, said the BoE had been too slow in raising rates to tackle inflation and was now compensating for that.

‘Waiting until December 2021 to first act was a policy error in my view, and the BoE is in a tight spot trying to get ahead of the curve again,’ he said.

‘We wouldn’t be surprised to see another 50bp hike in September and possibly even the same again in November, building to a 3% base rate in one year’s time.

‘Although rate hikes hit mortgage holders with a lag, as refinancings come due in the coming months there will be a considerable squeeze on disposable incomes.’

Recession is on the way

Neil Mehta, a euro bond fund manager at BlueBay Asset Management, said UK assets could soon find themselves against an ‘ugly backdrop’.

‘Before the meeting, there was a question whether the BoE might wait until the growth picture was clearer and a new prime minister’s fiscal plans laid bare before deeming it necessary to accelerate the pace of tightening,’ he said.

‘In the end, a headline CPI projection of 13.3% in Q4 coupled with a further rise in agents’ wage settlement [wage inflation] forecast to 6%, left the BoE with little choice but to act “forcefully” as per their communication at their last MPC meeting.

‘The BoE now expects the economy to shrink in 2023, and the high uncertainty around the inflation trajectory means policy is no longer on a pre-set path. This opens up an ugly backdrop for UK assets, which will continue to weigh on the pound and UK gilts.’

Market reaction

Thomas Wells, who manages the Sanlam International Inflation-Linked Bond fund, said that UK government bond yields had already failed in reaction to the decision.

‘Although the half-percent rate hike was in line with the consensus of economist forecasts, the gilt market initially reacted by pushing yields lower across the curve,’ he said.

‘The market seems to be more focused on the worsening outlook for the UK consumer as a result of the higher energy and fuel prices, and now the increase in the cost of servicing variable rate mortgages or refinancing fixed-rate deals that have expired.’

He said the BoE should continue to raise rates if high inflation levels persist.

‘The BoE must respect its mandate and tighten even if it increases the likelihood of a recession,’ he said.

More hikes on the way

Philipp Burckhardt, a bond fund manager at Lombard Odier IM, said that monetary tightening by other central banks had allowed the BoE to raise its rate.

‘With the Fed and ECB both stepping up their tightening pace recently, this opened the door for the BoE to tighten more than they could have otherwise,’ he said.

‘Rate hikes are unlikely to end here with the bank rate not peaking until nearer year-end or early next year.’

Seema Shah, chief strategist at Principal Global Investors, said that the 0.5% hike was the ‘minimum action required by the Bank of England at this stage’.

‘With inflation set to hit 13% later this year and set to remain stubbornly high through next year, the central bank needs to tighten policy at an accelerated pace,’ he said.

‘Indeed, with other developed market central banks already hiking by 0.5% or more, it’s a wonder that the Bank of England had been steadfastly sticking to 25bps hikes for so long.’

Shah said she feared for the future of the UK economy and its consumers.

‘Higher mortgage payments and borrowing costs will only add to the awful cost-of-living crisis, straining household budgets in a way we haven’t witnessed for over 60 years and plunging the UK into recession later this year.’

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