The Art Of Expectations Management A Bleak Outlook From The Bank Of England As It Scales Back Rate Hike Expectations

5th November 2022

The Bank of England has raised rates by 75 basis points today - the eighth successive increase and the largest since 1989 - to 3 per cent, the highest since November 2008.

Despite this historic rise, the big news was that the Bank signalled very clearly that market expectations for further rate rises had gone too far, amidst a bleak outlook for the UK economy. While this is good news for around 1.2 million households on variable-rate mortgages, it is still likely that, by the end of 2024, 5.1 million households will see their mortgage costs increase substantially, with an average annual increase in the region of £3,900 relative to Autumn 2022. Moreover, the Bank's updated forecasts showed a grim outlook for the UK economy, with GDP set to contract for two years starting in Q3 2022.

This would be the longest recession on record, and would mean that the economy ends this parliament smaller than it was at the start. Unemployment is also forecast to rise by around 1 million, to levels not seen since the financial crisis. A sliver of good news is that inflation is now set to peak somewhat lower, at 10.9 per cent in October (compared to 13.3 in the Bank's previous forecast), before falling back through next year. Real post-tax household income is projected to fall by around £800 next year, illustrating the scale of deepening cost-of-living crisis.

But the Bank's forecasts suggest that those on lower incomes are likely to be disproportionately hit with the food inflation - which makes up a larger share of spending for those on lower incomes - set to stay above 15 per cent for at least six months.

All this makes clear the challenges facing the Chancellor as he prepares for an Autumn Statement in which he must balance supporting people through the tough period ahead, with repairing the public finances. In this context, the Bank has done the Chancellor a huge favour by acting to push down market interest rates which will feed through into a lower cost of borrowing for the Government.

Huge rate rise but Bank reins in expectations of future rises
The Bank today tightened policy for an eighth successive meeting – by 0.75 percentage points, its eighth successive rise and the largest since the 1980s – but signalled rates would not rise above 5 per cent, as markets had (until today) been expecting.

As shown in Figure 1, the rate curve used to underpin the MPC's projections embodied rate rises to around 5.25 per cent (based on rates in the seven days to 25 October). But the Bank provided clear guidance that this was too high and that we should expect rate rises, but "to a lower peak than priced into financial markets". Rates have fallen since the Bank’s data cut off (see yellow line in Figure 1), and even before factoring in any reaction from today’s announcement suggested rates would peak at around 4.75 per cent. This is, however, still the sharpest rate-tightening cycle in more than 30 years.

Note
This article is from The Resolution Foundation. To read it in full go
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