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Rate Rises by the Fed and BoE on Pause

(2 minute read)

Today’s decision by the Bank of England to keep interest rates unchanged followed the same outcome by the US Federal Reserve last night. The Fed’s decision to announce a ‘hawkish pause’ was widely expected with US inflation falling to 3.7% on a year-on-year basis, although the core rate does remain stubbornly high at 4.3% and well above the 2% target. Having led the charge to tighten policy and fight inflation, the Fed has the credibility to see how 5.5% of rate increases since the end 2021 will impact the economy and inflation going forward, given the leads and lags of policy decisions. The Fed last night were also keen to emphasise the possibility of another rise in interest rates before the year end.

The position of the Bank of England’s Monetary Policy Committee (MPC) might not be as benign. Yesterday’s better than expected inflation data should be put into the context of a much higher rate relative to the US and the Euro Zone. Headline inflation fell to 6.7% from 6.8% year-on-year, although the market was expecting a rise to 7%. To be fair to the MPC, its decision to pause could be supported on the back of a larger fall in core inflation from 6.9% to 6.2%.

However, the Bank of England was slow to recognise at the outset that inflation was not transitory and suffered credibility as a result. With UK inflation higher than other developed economies the risk the MPC has taken now by pausing is that if inflation does remains sticky, interest rates will have to rise more aggressively further out. A stitch in time saves nine could ultimately prove to have been the safer strategy. GBP sold off against the USD and EUR and longer gilt yields increased 11 basis points, a possible warning from the market that the MPC might fall behind the curve. A weaker currency makes the job of bringing down inflation harder.

I don’t think this changes our view that we are getting closer to the peak in interest rates generally, and bonds look more attractive relative to other asset classes than they have done for some time, justifying the increased exposure in our allocation.

Peter Geikie-Cobb | Head of Investment Research
Montgomery Associates

21st September 2023