Bank of England’s 50 bps rate hike threatens an economic downturn in the UK

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Vrasidas Neofytou
Head of Investment Research

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Bank of England’s 50 bps rate hike threatens an economic downturn in the UK
The Bank of England raised- as widely expected- its key interest rate by another 50 basis points to 4% on Thursday, the highest it’s been since the 2008 financial crisis, to fight the inflation which is still running above the 10% level (10.5% CPI in December).

Despite the new rate hike, the Pound Sterling fell to as low as the $1.2180 level on Friday morning, nearly 2% down from a weekly high of $1.24, before stabilizing to nearly $1.2260.

Meanwhile, the yield on the 10-year Gilt (UK government bond) dropped to nearly 3%, its lowest since November 2022 (it topped at nearly 4.60% in mid-October), following some more-dovish messages-than-the market had expected from BoE.

During the regular press conference after the rating announcement, Governor Andrew Bailey had hinted that the Bank of England may have finished raising interest rates after the 50 basis points hike on Thursday, which had increased the possibility of an end to its policy tightening.

According to the BoE’s calculations, the current market expectations of a peak in rates around 4.5% in mid-2023 would push inflation below its 2% target in the medium term. That suggests it doesn't see the need to raise the Bank rate much more, if at all, although it was careful to add those uncertainties around this outlook are high and that "the risks to inflation are skewed significantly to the upside", said the Governor.

Risk for a recession in the UK in 2023:

The surging rates could add further pressure on the already-beaten-down U.K economy, which is struggling with record-high energy and food prices, with the inflation rate -10.5%- running much higher than in the U.S. and Eurozone, amid a tighter-than-expected labor market coupled with wages pressure.

That’s why the IMF- International Monetary Fund expects the U.K. to be the only G7 economy to fall into recession in 2023, with the annual GDP to contract some 0.6%, predominantly due to higher taxes, rising interest rates and the high cost of energy as well as lower government spending.

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