DWS: Bank of England will raise interest rates by 75 basis points

October 31, 2022

The Bank of England will raise interest rates by 75 basis points to 3% on Thursday, said Kathrin Löhken, UK Economist at DWS. And the central bank will not stop at this sharp increase, Löhken expects. "The new growth and inflation forecasts will show that this is not the end of the story: fighting inflation is a priority over supporting the economy. Moreover, active sales of the bond portfolio will finally start in November, which also reflects the tightening price of the BoE."

The United Kingdom's political turmoil hasn't exactly made the job of the British central bank (BoE) any easier. Since the last meeting, the second prime minister has been in office. The slump on the British bond market, triggered by a misguided fiscal expansion, has forced the BoE to take temporary emergency measures; moreover, it has had to postpone the start of the active sales program for its bond portfolio. In addition, current real economic indicators are pointing in the direction of recession.

However, the fiscal outlook is likely to have the strongest influence on the central bank's upcoming interest rate decision, which is due on November 3. The just-introduced government Energy Price Guarantee and the reduction in social security contributions will provide relief for citizens over the winter, which should at least mitigate the expected recession. The new budget, which has been delayed until mid-November, should show stronger consolidation efforts. As the budget presentation comes after the central bank meeting, the BoE cannot take all details fully into account in its new growth and inflation projections. Even if the expected fiscal austerity takes pressure off the central bank again, there are still strong arguments for a hawkish hike in the key rate. For one thing, the temporary energy price cap means that inflation will fall more slowly than expected in the coming year.

On the other hand, the tight labor market and unchanged high wage settlements mean that there is still a risk of second-round effects, which the central bank will have to counter. Thus, some central bankers already pledged to a "forceful response" to the inflation risks. We expect a strong rate hike of 75 basis points, which would take the policy rate to 3.0 percent. And the new growth and inflation projections should show that this is not the end of the story: fighting inflation takes priority over supporting the economy. In addition, the active sale of the bond portfolio is likely to finally start in November, which will also underscore the BoE's tightening course.