Little more than a week ago, investors thought it was a done deal that the Bank of England would press ahead with yet another increase in interest rates when its Monetary Policy Committee meets this week.
By the end of last week, pricing in financial markets suggested that the chances of a policy move on Thursday would be no better than even.
Successive scares in the financial sector did not deter the European Central Bank from raising interest rates by 50 basis points last week, sticking to the script it had set earlier in the year.
But even before the collapse of Silicon Valley Bank — let alone the weekend’s frantic negotiations to forge a rescue deal for Credit Suisse — the case for a further rise in the UK’s benchmark interest rate, which has climbed from 0.1 per cent to 4 per cent in just 14 months, was less clear-cut.
“For central banks that believe they have a lot more tightening to do, for now it’s business as usual,” said Philip Shaw, economist at Investec. “Those that aren’t sure could put rates on hold. That’s the category into which we put the Bank of England.”
When the MPC last met in early February, it abandoned its previous guidance that further rate increases were needed, saying instead that it would act only on evidence of “persistent inflationary pressures”.
BoE governor Andrew Bailey warned investors earlier this month not to assume that UK interest rates would rise further, as the UK’s inflation dynamics did not necessarily match those of the US and EU.
“At this stage, I would caution against suggesting either that we are done with increasing bank rate, or that we will inevitably need to do more,” he said on March 1.
Data released since then has shown that the economy was more resilient than expected in January, with GDP growth of 0.3 per cent pointing to a shorter, shallower downturn than feared.
This could be seen as vindication of the arguments put forward by Catherine Mann, the most hawkish member of the MPC, who argued in February that a year of policy tightening had not yet had as much of an effect as expected, and that more was needed “sooner rather than later”.
Kallum Pickering, economist at Berenberg, said that “short of something going drastically wrong”, this pointed to a further 0.25 percentage point rate rise on Thursday, as “with less worry about recession, policymakers will probably feel more confident to lean a bit harder on domestic inflation pressures”.
Andrew Goodwin, at the consultancy Oxford Economics, took a similar view, saying that while the situation was “incredibly volatile”, he expected the MPC to vote through one last quarter-point increase.
“A majority of MPC members will want to raise interest rates by 25 basis points to make sure they aren’t going easy on inflation too soon,” said Paul Dales, at the consultancy Capital Economics.
The MPC will also need to take account of measures announced by chancellor Jeremy Hunt in last week’s Budget, including further support for household energy bills, help with childcare costs and a £9bn tax break to boost business investment.
Although these could eventually strengthen the supply side of the economy, in the short term they are more likely to lead to stronger demand, which the BoE would need to offset to keep inflation on target.
However, other data could strengthen the arguments made by the more dovish members of the MPC — such as Swati Dhingra, who thinks that external price pressures are already easing and that there is little evidence of wages spiralling upwards at a pace that would keep inflation too high.
Inflation fell to 10.1 per cent in January, in line with the BoE’s forecasts, but a sharp drop in service sector inflation could be more significant because this is a better reflection of underlying pressures.
The backdrop in the labour market also looks more benign. Although there are still more than 1mn vacant jobs, private sector wage growth is finally slowing and the workforce is starting to grow again.
The MPC will see one more key set of data — February’s inflation print is out on Wednesday — before taking its decision. It will also have a clearer view of the extent of problems in the global banking sector, and will know whether the US Federal Reserve sees these as sufficient reason to slow or pause its own rate-raising cycle.
“By far the biggest issue . . . will be inflation versus financial stability,” said Thomas Pugh, economist at RSM, who thinks that the flare-up of risks will lead the MPC to “press pause earlier”.
The BoE’s own message on Sunday, after Swiss authorities engineered the takeover of Credit Suisse, was that the UK banking system was “well capitalised and funded and remains safe and sound”.
But even if the problems seen so far are contained, and do not become broader systemic issues, they show that rising interest rates are now having a tangible effect on both the financial sector and the real economy, with tighter financial conditions now likely to do some of central banks’ work for them.
“The situation is still very much in flux,” Dales said. “The fact that problems in the banking system . . . can be traced back to the rises in global interest rates means it is natural for the MPC to become more wary about further tightening the screws.”