The decision taken by the MPC last month, in response to the May inflation data, has brought the prospect of a recession close according to a renowned investment manager in the City.

The fact that the Bank was forced to change tack on its cycle of interest rate hikes after so long shows that it is far from being on top of the problem.

The data releases for May and the current level of inflation have led Schroders Investment Managers to believe that the base rate will reach 6.5% later in the year. It is probable that a further fifty-point hike will be agreed in August before the Bank feels comfortable returning to two twenty-five-point hikes later in the year.

Megan Greene, who joins the MPC this week, spoke in an article published yesterday by the Financial Times of her view that Central Banks would do well to be cautious about expecting inflation and therefore interest rates would settle back down to their now long-established level.

There are too many imponderables within the global economy currently to be certain that “normal service will be resumed.”

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Silvana Tenreyro has been an independent member of the Bank of England’s Monetary Policy Committee since August 2017. Over that time, she has “grown into” her role as its most dovish member.

In her final speech as a member of the committee, she spoke of her concern that if the Central Bank continues to hike rates, it will drive inflation to below the Government’s target of 2%.

She believes that the economy has suffered an external shock as energy prices climbed over the past eighteen months, and while it was correct to hike rates through 2022, the hikes that have taken place over the past few months run the risk of being “counterproductive”.

This is the type of radical thinking that looks beyond the “norm,” that several MPs believe should be encouraged by having fewer Bank of England employees on the MPC and more independents.

Members of Parliament believe that the current makeup of the committee runs the risk of adopting “groupthink,” in which they vote as a bloc, thus negating the role of the independent members.

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Andrew Bailey has defended the fifty point rate hike agreed by the MPC last week, while at the same time tried to explain to the market that it is not the Central Bank’s goal to see unemployment rise, although the committee is well aware that firms will need to “rationalize” their workforce as they experience a drop-off in demand.

Headline inflation is still “far too high”, and the Bank believed that it had to make a statement of serious intent when the May price data was released.

Having voted for a twenty-five pointy hike last week, Silvana Tenreyro, speaking at the ECB annual conference in Portugal, shared the belief that she holds with another independent member of the MPC, that pay growth and core inflation are set to slow considerably and rather than further hikes, the Bank of England may be forced to cut rates later in the year to stimulate the economy.

That is, however, not a view held by a majority of the MPC, who acknowledge that their actions will slow the economy, but not to such an extent that it will contract over an extended period.

Interest rates may have now reached a “neutral position” where they are neither supportive nor restricting demand.

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Speaking at an event hosted by the ECB yesterday, Andrew Bailey continued the hawkish rhetoric he used when announcing the fifty-basis point increase in interest rates last week.

He told the assembled journalists that having studied the surprisingly bad May inflation report that a strong message needed to be sent to the market.

There was discussion about hiking by fifty basis points over two meetings, but, on balance, the MPC felt that a single rise would hold a more effective message.

The effect of the employment and inflation reports made it clear that if the Bank was to be considered serious about the need to bring inflation under control, a strong message needed to be delivered.

The Treasury is believed to be concerned about the comments attributed to Bailey recently in which he was sanguine about rate hikes raising unemployment as demand in the economy.

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Backbench members of the ruling Conservative Party are very used to trying to find a scapegoat to deflect the blame for their often-poor performance.

This was particularly clear during the Pandemic, and it is happening again as the economy stumbles along. It is more due to luck than judgment that the country looks likely to just about avoid falling into recession.

The scapegoat this time around is Bank of England Governor, Andrew Bailey, who is a solid technocrat who lacks the charisma of his predecessor, Canadian, Mark Carney.

Carney was struck in the mould of earlier Chairmen of the Federal Reserve and commanded the respect of politicians and businesspeople alike, while Bailey appears to be a little “lightweight” for the role.

Therefore, he appears to be an easy target to blame for the current cost of living crisis and is facing pressure to resign from the aforementioned MPs.

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In his speech following last week’s rate increase announcement, The Governor of the Bank of England, Andrew Bailey, spoke of his concern that at least part of the continued rise in inflation is being caused by what he called unsustainable wage increases.

There is no reliable data for the level of pay settlements that have been agreed, but in the public sector, the Government has tried to stick to the pay award that has been recommended by the independent pay arbiters.

Bailey has used this reasoning in the past but fails to abide by his words closer to home. Each of his colleagues who make up the Monetary Policy Committee earns more than £300k a year, with Bailey himself taking home around £600k in pay and bonuses last year.

It is felt that pay and, more particularly, bonuses should be linked to productivity, output, and performance, but with inflation remaining uncomfortably high, it is hard to make a case for anyone on the MPC to have performed at, or above, expectation.

At last week’s MPC meeting, the hike was agreed by a majority of 7-2. In the past, the two less hawkish members, Swati Dhingra and Silvana Tenreyro, have voted to leave rates unchanged, this time, both voted for a twenty-five-point hike.

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The Prime Minister, in a TV interview yesterday, said that the people of the UK must “hold their collective nerve” in the face of continued high inflation. He went on to say that fighting inflation is the priority for the Bank of England, and the Government can do little to influence it other than supplying all the support it can.

Following its surprise fifty basis point hike in short-term interest rates last week, the market now believes that the Central Bank is taking rising prices seriously, having adopted a relatively low-key stance to the situation despite hiking rates consistently since December 2021.

Analysts believe that the peak for interest rates will now be 6%, and this will be reached by the end of the year, by way of two or three further hikes.

Kwasi Kwarteng, the Chancellor under Liz Truss’ disastrous, albeit belief spell as Prime Minister last year, spoke out at the weekend, criticizing his replacement, Jeremy Hunt, for almost welcoming the possibility of the country being plunged into a recession as the Bank continues to hike interest rates.

While a recession is considered the “nuclear option”, to drive inflation down towards the Government’s target, both Hunt and Andrew Bailey have considered the possibility publicly, although neither is likely to welcome a contraction, particularly since the economy is still below the level it was at the start of the Pandemic.

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The Bank of England raised interest rates for the thirteenth consecutive meeting yesterday as the entire market expected they would. However, they surprised almost everyone by hiking by fifty basis points.

This was most likely in reaction to the May inflation report, which was released the previous day and showed that headline inflation was unchanged at 8.7% while the core actually rose to 7.1% after a reading of 6.8% in April.

The base rate of interest is now at 5%, its highest level for fifteen years.

The market, although taken aback by the newly hawkish stance of the Bank, appreciated that it was taking the lead in the fight against rising prices after an extended period in which it made a series of almost grudging “dovish hikes” each of twenty-five basis points.

This contrasted with the more proactive stance taken by the ECB and FOMC, each of which have hiked rates in larger increments over a similar period.

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If there were any lingering doubts over whether the Bank of England would raise interest rates when the vote takes place at its meeting which concludes later this morning, they were dispelled by the publication of the May inflation report.

Headline inflation was unchanged last month at 8.7% as the continued fall in energy prices was offset by the continued excessive cost of foodstuffs. While a twenty-five-basis point hike in short-term interest rates was virtually certain before the data was released, it is now “baked in”.

The Office for National Statistics, when considering the data and the lack of any change, particularly given that the Bank of England has been raising rates constantly since December 2021, believes that there is little option but to allow the economy to fall into recession as the “nuclear option” to curbing inflation.

While prices are rising across the board, it’s the repricing of fixed-rate mortgages that is having the most effect on the public consciousness. During Prime Minister’s questions in Parliament yesterday, the opposition leader, Sir Kier Starmer, clashed with Rishi Sunak over the Government’s handling of the cost-of-living crisis. However, he was particularly careful to put forward suggestions for what the Labour Party would do if, or more likely when, it comes to power.

When compared to the last time there was a series of concerted interest rate hikes, over two decades ago, there were significantly fewer fixed-rate mortgages than exist today. Therefore, the ability of the Central Bank to affect inflation is “diluted” as the effect of rate hikes is spread over time.

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An eminent consumer affairs expert in the UK spoke yesterday of how he had warned his clients of the impending mortgage “ticking bomb” as long ago as last Autumn.

He also expressed surprise that mortgage advisors who are now scrambling to find new fixed rate deals didn’t act more proactively at the time.

The Chancellor told Parliament yesterday that the Government was not about to provide support for those who have seen the interest rate on the two-year fixed rate mortgages more than treble in the past three months.

A number of City analysts believe that an unwelcome side effect of the Pandemic has been that there has been a growing reliance on Government support. The public has become used to schemes like “eat out to help out” and seeing the property market supported by stamp duty holidays.

Unfortunately, the current mortgage crisis is little more than a tough fact of economic life. Interest rates do go up as well as down, a detail that has become lost on members of the public who have travelled through half of their “mortgage journey” never having experienced a single rate hike, let alone a series of them.

Beyond Currency Market Commentary:

Aims to provide deep insights into the political and economic events worldwide that can cause currencies to change and how this can affect your FX Exposure.