BOE marks half-time in lagged rate squeeze

A general view of the Bank of England in the City of London, Britain, September 25, 2023. REUTERS/Hollie Adams Acquire Licensing Rights

LONDON, Nov 3 (Reuters) – The Bank of England reckons the UK economy has only felt half the effects of a near two-year interest rate squeeze so far – and markets doubt it will allow it to take the whole dose.

A brutal five percentage point rate hiking cycle that started late in 2021 may well have ended but its hit on household demand and economic activity to date may well double from here, according to the BoE’s own calculations.

And that’s assuming the Bank just leaves them here for a protracted period, in what its chief economist Huw Pill repeatedly dubs the “Table Mountain” strategy.

But reasonable doubts that the already spluttering British consumer and flat-lining economy can take the full force of what’s already in train has markets betting the central bank will have to pull back again with rate cuts within nine months.

If true, that means the walk across the plateau of the rates mountain only lasts less than half the time it took to climb it and a climbdown may be underway up to six months before the Bank sees maximum impact from decisions taken to date.

The BoE’s voluminous Monetary Policy Report, released alongside its decision to hold policy rates steady at 5.25% on Thursday, assessed the delay with which credit tightening enacted so far is eating into household wallets.

“Bank staff estimate that more than half of the impact on the level of GDP is still to come through,” it said, reckoning it could take until 2025 for the GDP hit to be close to fully felt – based on past relationships, expected mortgage and loan refinancing and despite “significant uncertainty”.

In making that call the BoE report focuses mostly on consumption, which it estimates makes up about 60% of GDP.

And for that it offsets the impact on higher savings income with the higher mortgage costs – where some 80% of are now on two-to-five year fixed rate deals, far more than the last time it went on a rate hike campaign, and so delay the hit.

Reuters GraphicsBoE hits a plateau?UK surprise index turns negative for the first time since February

Perhaps remarkably to many, it says the net fallout on aggregate income from any given rise in interest rates is positive – given that close to 1.7 trillion pounds of household deposits exceeds the 1.5 trillion in outstanding mortgages.

However, given that higher savings income is skewed to wealthier households that have a much lower propensity to consume additional income than less well off and more indebted ones, the positive net effect on the economy is snuffed out.

Other impacts include the effect on consumption from lower home values or savings in financial securities – as well as hits to housing and business investment and from higher rents due to higher mortgage refinancing for buy-to-let landlords.

As a result, the BoE expects the fallout from rate moves to date to “grow over time” even if one-off quarterly hits have peaked.

Of course, the Bank’s central mandate is getting inflation back to its 2% target and it nudged up inflation projections in this week’s report – now not seeing its goal reached in full until late 2025.

But markets clearly think the second half of the standing rate crunch and downward trajectory of inflation will force its hand to cut rates as soon as next year – once it’s confident moderating pay growth is sustained beyond the Spring wage round.

And some fear the risk of a shaken ketchup bottle effect – of what seems like a slow delayed hit all coming out in one very fast splurge all of a sudden.

AXA Investment Managers’ economist Modupe Adegbembo pencils in two quarter point cuts in August and November to 4.75% by the end of 2024.

But “there is a risk that the BoE could be forced to unwind rates earlier and faster if the growth outlook deteriorates … particularly as the pass through from rates was slower than expected on the way up.”

The flip side is that very little in the post-pandemic cycle has been easily predictable. And whatever the slow-burning hit to growth and consumption, inflation surprises could well change the increasingly comfortable markets picture.

“Although rate cuts are now priced into the second half of 2024, investors should remember that the outlook remains unclear – a plateau covered in fog may yet turn out to be hiding Mount Everest,” said Insight Investment’s Andy Burgess.

BOE chart on GDP outlookBOE chart on consumption hit from rate risesReuters Graphics Reuters Graphics

The opinions expressed here are those of the author, a columnist for Reuters

by Mike Dolan X: @reutersMikeD; editing by David Evans

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Mike Dolan is Reuters Editor-at-Large for Finance & Markets and has worked as an editor, correspondent and columnist at Reuters for the past 26 years – specializing in global economics, policymaking and financial markets across the G7 and emerging economies. Mike is currently based in London, but has also worked in Washington DC and Sarajevo and has covered news events from dozens of cities across the world. A graduate in economics and politics from Trinity College Dublin, Mike previously worked with Bloomberg and Euromoney and received Reuters awards for his work during the financial crisis in 2007/2008 and on frontier markets in 2010. He was a regular Reuters columnist in the International New York Times between 2010 and 2015 and currently writes twice weekly columns for Reuters on macro markets and investing.