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Bank of England poised to raise interest rates to 4.25% amid inflation surprise jump

Bank of England interest rates
The Bank of England will announce its decision on interest rates on Thursday. Photo: PA/Alamy (John Walton, PA Images)

Markets are almost certain the Bank of England (BoE) will ignore the Credit Suisse (CS) chaos and hike interest rates this Thursday as inflation made a surprise jump to 10.4% in February.

City analysts have tipped Bank governor Andrew Bailey to prioritise fighting inflation instead of banking stability and are anticipating an increase from 4% to 4.25%.

“The Bank of England’s interest rate decision on Thursday is coin flip between a 25-basis hike or no change in monetary policy” Fawad Razaqzada, market analyst at City Index, said.

“But knowing that the BoE has the option to use targeted measures to address financial stability risks – like it did during the mini-budget crisis of last year – and can use more traditional measures – i.e., changing the Bank Rate – to continue its fight against inflation, we lean towards a rate hike.”

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CJ Cowan, portfolio manager at Quilter Investors, said the Bank is looking for an excuse to pause hikes but might not be there yet.

“These events put central banks in an even tougher spot now as financial stability concerns have resurfaced but inflation still remains uncomfortably high and is showing signs that it won’t fall as far or as fast as hoped. The Bank of England appear to be looking for an excuse to pause hikes, citing the lags that monetary policy works over,” Cowan said.

Read more: Interest rates: Jeremy Hunt hints at Treasury backing for further rise

“Several Monetary Policy Committee (MPC) members are particularly concerned about the rate sensitivity of the British consumer given most mortgage rates are only fixed over a relatively short horizon, so it would not be a big surprise to see the BoE use recent events as justification to pause rate hikes.”

The Bank of England’s MPC is due to announce its latest decision on interest rates next Thursday. Rises at each of its last 10 meetings have taken UK base rates from a record low of 0.1% in December 2021 to 4%.

Just two of the Bank’s nine MPC members voted against an interest rate rise when it last met in February.

BoE policymaker Swati Dhingra has called for UK interest rates to be kept on hold, warning that another increase risks 'deepening the pain' for households.

MPC member Dhingra said a "prudent strategy would hold policy steady" after raising rates at 10 consecutive meetings.

Some analysts are still holding on to the idea that a half point hike is a real possibility. James Smith, developed markets economist at Dutch bank ING (ING), said: “We’re still narrowly leaning towards a hike this week, though clearly, a lot can change in the days leading up to the meeting.

“We think the BoE will probably opt for one final 0.50% hike on Thursday.”

Overall, investors now see a roughly 5% chance of a 0.5 percentage point hike, according to a Refinitiv poll.

Analysts have also highlighted that central banks could spark investor jitters if they leave rates unchanged by suggesting they know of underlying risks in the financial system that market participants are unaware of.

Deutsche Bank (DBK.DE) has maintained its forecast for a 0.25 percentage point increase but Sanjay Raja, chief UK economist at Deutsche Bank, said the situation is live.

Read more: Bank of England's assessment of UK economy hints at rising interest rates and prices

“We expect a 6-3 vote split (25bps vs 0bps), with Jon Cunliffe – the Bank's Deputy Governor for Financial Stability, joining the doves. The rest, we expect will vote for a 25bps hike,” he said.

“The bar for further rate hikes will undoubtedly be higher, with the Bank likely to signal a more cautious approach to mitigate the risk of overtightening, especially given the long lags in monetary policy transmission. That said, should underlying price momentum stay sticky for longer, the MPC may be forced back into one or two more hikes to temper inflation expectations.”

Kate Anderson, deputy editor at personal finance comparison site finder.com, expects the BoE to hold rates at 4% for now.

"I believe the collapse of SVB and the recent rescue of Credit Suisse will make the Bank of England take pause. There’s a fear that there could be hundreds of banks depending on cheap finance. Combine this with unexpected falls in inflation and renewed momentum in the economy, and the drive for monetary tightening may lessen.

“Although I expect the MPC to hold interest rates steady at 4% this week, that doesn’t necessarily mean the end of this rate-hiking cycle. We are still likely to see at least one more rise this year.”

EY Item Club chief economic adviser Martin Beck declared, after more than a year of speculation about the size of the increase, “the focus has now moved to whether rates will rise at all”.

He said: “The EY Item Club thinks there’s a good chance they will not."

Mr Beck added: "Given the new uncertainties surrounding the outlook and more reassuring news on inflation, the EY Item Club thinks that the MPC will forgo the 25 basis points rise in Bank Rate in March which, until recently, had been widely expected. This would give time to both see how current financial uncertainties pan out and to absorb how other central banks respond.

Read more: Bank of England survey shows most expect interest rates to rise

"After this month, the MPC meets next in May. The MPC could proceed with a rate rise in May, but the EY Item Club thinks the peak has already been reached.”

Barclays has scrapped its expectation for a 0.25 percentage point rise in the Bank Rate on Thursday following UBS’s emergency takeover of Credit Suisse and the collapse of Silicon Valley Bank in the US last week. Now, it expects the Bank will hold rates at 4%.

Silvia Ardagna, chief European economist at Barclays, said: “In light of elevated tensions in the US and European banking systems, we change our call and expect the Bank of England to pause next week and reassess the need for further hikes at the May meeting.”

Investec has downgraded its expectations for Thursday’s decision from 4.25% to 4%, citing increased concerns over financial stability.

If the market wider expectation of a 25 basis point hike to 4.25% comes through, mortgages could rise by £312 a year.

Research conducted by TotallyMoney and Moneycomms found that another base rate hike to 4.25% would see the monthly mortgage repayments for the average UK property costing £270,708 on a variable rate and with a 75%t loan-to-value increase by £26.

This means that over the space of a year, households would be forced to pay up an extra £312 over the period. For a £150,000 property, an 0.25 increase would mean an additional £18 per month.

Watch: How does inflation affect interest rates?

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