Bank of England’s possible interest hike poses risk of overtightening


  • Financial markets are expecting the Bank of England (BoE) to raise interest rates by another quarter-point, reaching 5.5%, the highest level since early 2008.
  • While there is confidence in the BoE’s decision to raise rates due to inflation concerns, there have been conflicting signals from the BoE.
  • The upcoming inflation figures for August are anticipated to show an increase, potentially pushing headline inflation above 7%.

Financial markets are anticipating that the Bank of England (BoE) will implement another quarter-point increase in interest rates at its upcoming meeting on Thursday. This move would bring the borrowing cost to 5.5%, marking its highest level since early 2008. Presently, markets are factoring in approximately 18 basis points for this week’s meeting.

Although forward guidance is likely to be restrained, there is a possibility that the monetary policy committee could adopt a dovish tone by suggesting that the Bank Rate may be approaching its peak if it hasn’t already reached it by Thursday. Additionally, it is expected that the Monetary Policy Committee (MPC) will reiterate that the current monetary policy stance is restrictive and emphasize their commitment to ensuring that the Bank Rate remains sufficiently restrictive for an extended period. 

This sentiment has recently been echoed by several committee members, including Bank of England’s chief economist Pill, who expressed a preference for a “table mountain” approach, advocating for steady rates over a longer duration.

Bank of England faces the risk of overtightening

The high level of confidence among economists and financial markets regarding the Bank of England’s (BoE) decision to raise rates again is rooted in the BoE’s guidance that they would take such action if there were continued indications of persistent inflation. This sentiment has been reinforced by recent data on wages and the cost of services.

However, there have been conflicting signals emerging from the BoE in recent weeks. Some members of the Monetary Policy Committee have sought to introduce some uncertainty over the September decision, especially now that borrowing costs have reached a level that could potentially curb economic growth and inflation.

BoE Chief Economist Huw Pill suggested that if the Bank of England were to raise rates further and subsequently have to cut them, or if the BoE opted for a pause and kept rates at their current levels for an extended period, inflation would likely decrease. He indicated a preference for the latter approach.

Governor Andrew Bailey and Deputy Sir Jon Cunliffe, in their testimony to MPs, agreed that interest rates were much nearer the top of the cycle. Meanwhile, MPC member Swati Dhingra indicated concern that interest rates may have already risen too far, posing a significant risk of over-tightening.

Although four of the nine MPC members expressed uncertainty about the necessity for further rate hikes, economists believe that the data since the rate setters’ meeting in early August has been too inflationary for an immediate pause.

Private sector wage growth of 8.1% in the year to July and services inflation of 7.4% significantly exceeded the Bank of England’s forecasts in August. Nevertheless, analysts anticipate that the 15th rate hike in this cycle could mark the end, with expectations of a “dovish hike” to 5.5%. It is anticipated that the majority of the committee may now believe that rates probably do not need to rise further. Capital Economics and Deutsche Bank both indicated that the upcoming quarter-point rise is likely to be the final one in this cycle.

Inflation uptick incoming 

The upcoming inflation reading is anticipated to show an increase after months of deceleration, which could have significant implications for the Bank of England’s decision on whether to implement the highest interest rate since 2008 or consider a pause in rate hikes for the first time in 15 meetings. The Office for National Statistics (ONS) is set to release the inflation figures for August on Wednesday, and it could suggest that price increases may be picking up pace once again.

A surge in oil prices, triggered by announcements from major exporting countries like Russia and Saudi Arabia about production cuts, led to a rise in the prices of various forms of energy and fuel during August. That is expected to push headline inflation above the 7% mark, with economists forecasting a rate of 7.1%, up from 6.8%. If these projections hold, it would mark the first increase in inflation since February.

However, since energy prices drive this rise and reflect international actions rather than domestic price pressures, it may not be the primary focus for the Bank of England. The Bank’s projections already account for an increase in inflation in August.

Nevertheless, expectations for inflation over the next five years have slightly decreased, easing from 3% to 2.9%. That represents their lowest level since May 2021.

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Yvonne Kiambi

Written by Yvonne Kiambi

Yvonne is a blockchain and crypto enthusiast. She is passionate about writing and looks to effortlessly guide readers through the exciting world of crypto. You'll find her immersed in a good book when she's not writing.