Bank of England raises rates, but dovish on future hikes

( 3 min )

Sterling fell against its peers after Thursday’s Bank of England announcement was much more dovish than the market had anticipated.

nterest rates were raised by 25 basis points to 0.75%, as expected, the third hike in as many meetings. The vote on interest rates was not unanimous. While eight of the nine MPC members were in support of a quarter of a percentage point move, Jon Cunliffe was a surprise dissenter in favour of no change. We had also expected at least one or two committee members to vote in favour of a 50 basis point hike, particularly after four had done so in February. According to Cunliffe ‘the very material negative impacts of higher commodity prices on real household incomes and activity’ justified his dissenting vote.

We think that even more significant was the toning down of the language on interest rates in the bank’s statement. In its statement, the BoE noted that further tightening in policy ‘might be appropriate’, a downgrade on its February communications when it stated that it was ‘likely to be appropriate’. The bank revised upwards its near-term assessment of UK inflation. The MPC now expects inflation to reach 8% in the second quarter, and possibly higher later in the year, although this is expected to suppress economic activity during the remainder of the year. The minutes are also much more dovish on long-term inflation than we had anticipated, noting ‘further out, inflation was expected to fall back materially and possibly to a greater extent than had been expected in February.’

Overall, a dovish message that suggests policymakers are growing increasingly concerned about the impact of rising prices on consumer demand, particularly higher commodity prices that are out of the bank’s control. This makes it difficult to see how the BoE raises rates as swiftly as the market is currently pricing in, which presents a bit of downside risk to sterling.

US dollar retreats on Ukraine optimism

Elsewhere in markets, the dollar edged lower against most currencies yesterday, as investors continued to take a cautiously optimistic view on negotiations between Russia and Ukraine. According to the Kremlin, Russia was putting ‘colossal energy’ into discussions, with markets hopeful that a ceasefire is not too far away that would allow a peace deal to be struck. Indeed, optimism levels have been more than enough to reverse any brief gains experienced in the dollar following Wednesday’s FOMC announcement. The Fed raised rates for the first time in the pandemic era, while signalling it expects to hike on a further six occasions during the rest of the year. But, with expectations for Fed tightening already sky-high, the greenback has found gains very difficult to come by in the second half of the week.

Today bodes to be a relatively quiet end to the week in markets, with not a huge amount of major newsflow on the docket. We will continue to be watching developments out of Ukraine very closely, with any signs of a possible breakthrough in talks likely to be perceived as positive for risk sentiment.

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