The Bank of England (BoE) is set to lift its Bank Rate again from 0.25% to 0.50% when it meets on February 3, after making its first rate increase in three years in December.
Source: Bank of Singapore, Bloomberg.
We expect the BoE will raise interest rates three times in total this year to 1.00% given the labour market’s strong recovery from the pandemic and inflation overshooting the BoE’s 2% target.
This week’s key data releases in the UK were all stronger than expected.
First, the unemployment rate fell further in the three months to November to 4.1%. The first chart shows the UK jobless rate has thus almost returned to its pre-pandemic levels near 4.0%.
Source: Bank of Singapore, Bloomberg.
Second, December’s consumer price index (CPI) report showed inflation reached its highest level since 1992 at 5.4% on higher food prices. Core inflation, excluding energy and food, also rose to 4.2% as supply bottlenecks and the tight labour market exert upward pressure on goods prices.
Headline inflation is likely to peak near 7% in April when regulated prices for gas and electricity will be reset to reflect higher energy costs. The UK labour market is also likely to remain tight with Omicron cases keeping affected employees at home. Thus, the BoE is set to raise its Bank Rate to 0.50% next month and we expect further hikes in May and August to 1.00%. There is also a risk the BoE starts to reduce its balance sheet in 2022 - quantitative tightening (QT) - to help inflation return to its 2% goal over the next couple of years.
The second chart shows the prospects of further BoE rate hikes this year have been supporting GBP while UK equities haven’t been adversely affected by expectations of higher interest rates. Thus, current financial market conditions are not impeding additional rate rises in 2022.
Our forecast of three BoE rate hikes this year almost matches our forecast for the Federal Reserve to increase its fed funds rate four times in 2022 to 1.00-1.25%. In contrast, we expect the European Central Bank and Bank of Japan will continue to see inflation being transitory and thus keep their deposit rates at -0.50% and -0.10% this year - to the detriment of the EUR and JPY.
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