Will the Bank of England follow the Fed and raise interest rates?

The US Fed has raised interest rates once again, but it is dropping hints left, right and centre that the tightening cycle may be at an end. As ever, when it comes to central bankers, it’s best to watch their feet rather than their eyes, as they are practiced in the art of selling a dummy. There are however reasons to believe that in the US, rate hikes could be over for the time being.

The turmoil in the banking sector has been a gamechanger, with tightening credit conditions expected to do a lot of the heavy lifting when it comes to cooling the US economy, relieving the central bank of this task. Inflation is falling back and some froth has been blown off the labour market too, so expectations are now building for rate cuts later in the year. Current market pricing suggests there could be three rate cuts by the end of 2023 in the US. That seems out of kilter with the forecast of Federal Reserve policy makers, which are pointing to cuts in 2024, but not before. Whatever the precise timing, it seems likely we are now turning towards a new phase in the cycle where markets are on high alert for signs of rate cuts, rather than just a pause in rate hikes.

In the UK the inflationary picture is not so benign. CPI still stands in double digits, which means that everyone is expecting a rate hike from the Bank of England at the forthcoming policy meeting. In stark contrast to the US, markets are then expecting one further rate hike, possibly two, to be pushed through by the Bank of England. The UK’s headline inflation rate is running around twice that in the US, so it’s easy to see why we might have to swallow another few doses of monetary medicine.

Food and energy prices are the main culprits in producing unavoidable inflationary pressure on households and there is growing disquiet about elevated food inflation, even in the face of falling wholesale prices. Indeed, the Liberal Democrats have called for the competition watchdog to launch an inquiry into profiteering by supermarkets and food multinationals. It’s important to ensure that such a key part of the consumer economy is functioning well, though the supermarkets seem a surprising target for a competition inquiry. The UK supermarket industry is fiercely competitive, and margins of around 3% to 4% don’t immediately scream supernormal profits, nor does the poor share price performance of Tesco and Sainsbury’s over the last ten years. For some context, Apple’s operating margin is around 30% and its share price is around 10 times higher than it was a decade ago.

Whether by accident or design, food inflation is at record highs and will be one of the key metrics considered by the Bank of England in their monetary ruminations. While the Bank may deem higher interest rates necessary to tame rampant inflation, the harsh irony is this heaps even more pressure on household budgets in the short term. Certainly there appears little respite in view for those taking out a mortgage, and millions of people rolling off cheap fixed rate deals in the coming year will be in for a nasty shock. The silver lining, such as it is, is for cash savers, who will continue to enjoy reasonable rates of returns on their money after more than a decade in the wilderness. However, double digit inflation makes this a somewhat pyrrhic victory.

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