HOW WILL THE BANK OF ENGLAND'S RATE RISE AFFECT INFLATION AND EARNINGS GROWTH?
Raising interest rates and inflation expectations
Wednesday 10 August, 2022
In summary
- Bank of England increased interest rates by 0.5%, the largest single rate hike in 27 years
- There has been a sharp increase in inflation expectations
- The Bank of England predicts GDP growth will continue to slow before entering a recession in the final quarter of this year
Last Thursday, the Bank of England (BoE) Monetary Policy Committee (MPC) increased interest rates by 0.5%, the largest single rate hike in 27 years[1]. The committee appears to be turning increasingly hawkish, with eight of its nine members voting in favour of the 0.5% increase. This is in comparison to the more marginal 0.25% rises we have seen over previous months and represents a notable change in stance from the committee. Previous meetings have seen more of a split in voting by its members, with the last meeting having just a third favouring a larger singular increase[2].
Inflation and growth revisions
The meeting highlighted the MPC’s sharp increase in inflation expectations. As recent as the May meeting, CPI (Consumer Price Index) was expected to peak at around 10% in Q4 of 2022. This prediction has since been raised to 13.3%, largely due to the 70% increase in European wholesale gas prices since the May report. Despite the fall in commodities and oil prices since June, energy is still forecasted to contribute 6.7% of the 13.3% inflation[3]. It is anticipated that this will be most keenly felt in October, when the energy price cap is expected to be increased by 70%[4]. The effect of energy price rises also feeds into the wider services sector, which does not experience the same lag in energy price rises as consumers by the price cap.
The direct contribution of energy prices to CPI inflation*
*Energy prices include fuels and lubricants, electricity, gas and other fuels.
Source: Bank of England
Further economic pain will likely be felt by the UK consumer as real wages are squeezed. The BoE predicts GDP growth will continue to slow before entering a recession in the final quarter of this year. Currently, five quarters of negative output are expected, which will have detrimental effects on both consumption and the labour market. This does raise the question of why the BoE would add further misery to UK households via higher costs of borrowing. However, the alternative would likely be an even weaker pound (which means higher import costs) if rate rises don’t come to fruition, as well as higher wages from a tighter labour market pushing prices ever higher.
UK equities outlook
UK equity markets are heavily driven by energy and commodity prices. These prices will likely remain volatile over the coming months as the war in Ukraine shows no clear indicator of resolve. Global growth figures also remain unpredictable, particularly with respect to China, as their economic outlook will likely drive commodity prices. Whilst this trend has benefitted the FTSE 100’s largest incumbents year to date, the impacts on the UK consumer and wider economy cannot be ignored, and are unlikely to subside in the short-term.
