Bank of England joins the hiking party

At noon today UK time, the Bank of England (BoE) raised interest rates by 25 basis points, to 4%. The decision marks a reversal of the easing bias following the post-COVID inflationary surge of 2022–23, when rates peaked at 5.25%.

Having spent the subsequent years wrestling inflation back to target, the conflict in the Middle East has imposed an unwelcome return of price pressures. Bolstered by rising fuel prices, inflation has been ticking up since the summer, and policymakers will be mindful that broad inflation appears likely to lurch higher mechanically when energy tariffs reset in the new year.

Late to the party?

The BoE is a latecomer to this renewed tightening cycle. Both the Federal Reserve and European Central Bank moved in September, as inflation ticked up again amid the rise in energy prices, and oil in particular. For the BoE, weaker domestic demand and softer labour markets have complicated the decision. Nevertheless, stubbornly high inflation has left the central bank increasingly concerned that sustained increases in energy costs will spill over into broader wages and price-setting. Today’s move is as much about seeking to manage future inflation as it is containing its current rise.

Renewed tightening adds to an uncomfortable backdrop to the UK economy. Still-high borrowing costs weigh on household consumption, with little relief to consumers hit by high mortgage rates. Businesses face a similarly difficult combination of elevated input costs and more expensive financing. While a 25bp increase is unlikely to materially change the growth outlook by itself, in our view, further tightening could compound the squeeze on activity. The Bank must balance still-malleable inflation expectations without pushing the vulnerable domestic economy into a sharper slowdown.

Investment implications

For investors, we believe the decision itself is unlikely to be the main event. A 25bp increase was largely priced by the market. Attention instead centred on the BoE’s hawkish commentary on future rates.

Regarding fixed income, the Monetary Policy Committee vote surprised hawkishly and is likely to support front-end rates in our view, although persistent inflation and fiscal concerns remain risks for longer maturities. For solutions portfolios, however, we believe the higher rate path already reflected in bond yields creates a potential opportunity to selectively add hedges and better match contractual cashflows.

On the currency front, sterling may find support from higher relative yields, but much depends on developments elsewhere. As of today, the trade-weighted sterling index sits near its highest level for over 10 years. Meanwhile, UK equities face a mixed outlook: higher discount rates are a headwind for domestically oriented companies, while the FTSE 100’s international earnings exposure offers some insulation. We note that the FTSE 100 has jumped today and is flirting with an all-time high.

Ultimately, the path of energy prices, rather than today’s rate increase alone, will determine how far the Bank of England needs to go.

Assumptions, opinions, and estimates are provided for illustrative purposes only. There is no guarantee that any forecasts made will come to pass.