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Bank of England raises by 25 basis points

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For the first time since July 2007, the Bank of England has raised Bank Rate by 25 basis points today in a widely-expected move. The MPC voted 7-2 in favour of the hike. The question now is whether this move was merely a response to the last 25 basis point cut in August 2016 – now regarded as a mistake – or whether today’s increase presages further moves on the way to interest rate ‘normalisation’. Initial market reaction has been a classic ‘buy on rumour, sell on fact’ with 3 and 5 year swap rates down 3 and 4 basis points respectively. On the FX front, after an initial rally to 1.3273, GBP/USD has traded down over a cent to 1.3105, while GBP/EUR has also lost a cent to 1.1245. It seems everyone had bought sterling in advance and there were only sellers after the announcement.

Mark Carney will doubtless shortly be explaining at the press conference how the MPC is not about to embark on a sharp tightening process but one of very gradual normalisation with a peak in rates that will be much lower than ion previous cycles. This guidance will be important to reassure markets and overstretched consumers who continue to face declining real earnings. However, the reality is that the future path of interest rates will be, as always, data-dependent. If the recent blip in inflation does indeed turn out to be entirely due to sterling’s post-referendum weakness, all will be well. If, on the other hand, the consensus is wrong and the UK’s rising inflation turns out to be more cyclical in nature and part of a general ending of the global deflationary forces in place since 2008, then the market could yet be surprised by how far rates rise over the next couple of years.

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