The pound rose against the US dollar in early trade, its highest in a week. It was also higher against the euro after the European Central Bank’s policy update did not offer any signs that it will proceed to raising interest rates any time soon. The ECB’s guidance was similar to the last one in May and disappointed markets who were expecting that policy makers would be more decisive about a 2022 rate hike to fight surging inflation.

While inflation is a global concern, the ECB avoided signalling an end to its bond purchase programme and stated they would continue to buy assets even after they start raising rates. The euro weakened following the news.

Inflation to remain high

In its statement, the ECB said that inflation has increased considerably and will remain high in the coming months because of the high energy prices. The bank did not show it was extremely concerned about wider price pressures in the economy. Earlier in March, the ECB said that it would end its asset purchase programme one quarter earlier than before which helped to push the euro higher. This is why market expectations were high today, and market participants were disappointed as the statement was not as aggressive as expected and no new policy changes were announced.

Many investors were looking for a more “hawkish” tone as inflation has risen especially following the war in Ukraine. The ECB did not touch upon the issue of interest rate rises, despite that the market was expecting 60 basis points of hikes for 2022.

ECB Press Conference

In a press conference, ECB President Christine Lagarde said that the central bank was focused on ending the asset purchase programme before raising rates, with the first hike coming some time after the ending of the asset purchase programme. Lagarde said: "We will maintain optionality, gradualism and flexibility in the conduct of our monetary policy.” Analysts expect the earliest rate to come in December, with the 60-basis point being an over optimistic forecast.  

At the conference, there was no mention of the new emergency tools that the ECB was exploring if bond yields of peripheral economies rose. The ECB was creating a so-called backstop to be used against debt-market pressures outside the control of individual governments.

The ECB’s cautious tone today drove the euro lower as the market was not expecting a softer attitude amidst surging inflation. European Central Bank chief Christine Lagarde’s comments were seen as a sign that the bank was not in a hurry to raise interest rates and offered no hard schedule and little specifics beyond the coming months. As she said, “We'll deal with interest rates when we get there."

If you are a business transferring funds overseas, contacting a currency specialist could save you time and money. Get in touch with Universal Partners FX and their dedicated team to discuss the latest market movements ahead of your currency exchange. If you are transferring funds to pay your employees abroad, get in touch with Universal Partners FX to find out how much you can save in your international money transfers. Universal Partners FX can provide invaluable help on efficient risk management and tailored solutions to your business’ transfer needs.

In worrying times like this, it is important for us to point out that we completely acknowledge the wider implications of international conflict. Our principle duty as a company is to ensure that our clients are aware of all of the factors that affect currency exchange rates, which sadly sometimes includes war. Our thoughts are with everyone who is being affected by this escalating situation, and our currency updates do not intend to diminish, ignore or undermine the true impacts of this conflict.

Economic uncertainty due to the Ukraine war, rising inflation, soaring energy prices and the cost-of-living crisis have put more pressure on borrowers and will affect a major part of UK families. The Russian invasion poses considerable risks to the UK as it has fuelled the UK cost of living crisis and intensified uncertainty.

With Ofgem increasing the energy price cap by 54 per cent, higher fuel bills and a rise in national insurance payments, living standards will experience the sharpest drop in decades. Analysts have warned that more families will struggle with poverty, with low- and middle-income households facing the biggest challenges as energy, food and transport bills rise. Small companies will also be the most affected by rising energy prices according to a key Bank of England report.

Cost of living crisis

The current cost of living crisis is being driven by rising costs, including higher food, energy and petrol prices. High demand for oil and gas since 2021 as well as uncertainty about supply following the war in Ukraine and the subsequent sanctions against Kremlin, have pushed prices up globally.  These resulted in higher costs for energy companies which have been passed on to consumers.

UK inflation reached a 30-year high in March, and is expected to go higher, especially in April when prices go up.

What changed on the 1st of April?

Household budgets were immediately affected from the following changes:

  • Ofgem increased the energy price cap by 54 per cent. This is almost £700 annual rise in bills for those who pay by direct debit.
  • A 10 per cent national insurance increase which will impact on the lowest wage earners the most.
  • A 3.5 per cent council tax rise.
  • A freeze on the income tax threshold.
  • An average of 1.7 per cent rise in water bills.
  • Lateral flow tests will no longer be free for everyone in England, or the rest of the UK in the coming weeks.

Bank of England report

The Bank’s key Financial Policy Committee (FPC) has highlighted that if energy bills keep rising, then household and business finances will face more pressure, with the poorest families to struggle the hardest from the cost-of-living squeeze.

In its latest report, the FPC said: “An increase in the cost of living, partly due to rising energy and other import prices, is likely to affect household resilience across the income distribution, with a larger impact on lower income households that spend a greater share of their income on energy and other essential items.”

Borrowers will be able to continue with their mortgage repayments, but the FPC said their income strength will be put to the test while lower-income families will be hit the hardest.

 

The Russia – Ukraine conflict could disrupt supply chains and impact the UK and global economy, posing particular risks to small and medium sized firms, which are more vulnerable to surging costs. The report warned that “Companies in sectors most affected by rising energy prices will also face a greater cost shock.”

Higher energy prices and how to cope

The 54% rise in the energy price cap in April – up £693 a year means that even those households which consider themselves more comfortable will start to struggle too. Rising oil and gas prices will feed through into the price of manufactured or distributed goods, and consumers will face a widespread surge in prices.

For those of us, who might find themselves faced with these new challenges, it would be good to start finding ways to save money and energy, explore different deals by providers or simply try to save more.

You can cut back on spending and identify areas where you can afford to spend less. One of the ways to do so, especially if you are a company sending money overseas, is through your currency specialist. If you are using a bank, now is the time to explore alternatives and discover all the benefits you can receive by switching to a currency specialist such as Universal Partners FX. 

If your business is facing the weight of rising energy bills, then you can discuss a strategic plan with UPFX and find the best possible way to pay your suppliers overseas or the costs for importing goods. Taking a few steps now will help shelter your business’ finances and leave you free to focus on other important areas.

The pound is extremely sensitive to global market sentiment and concerns over a slowdown in UK economic growth in the coming months. Investors fear that this will also influence the Bank of England’s monetary policy decisions and could diminish expectations for future interest rate hikes.

The pound fell as higher oil prices resulted in a stock market selloff. Chancellor Rishi Sunak’s Spring Statement also contributed to the pound’s weakness as it offered a disappointing assessment of the UK economic outlook. The Chancellor said that “The actions we have taken to sanction Putin’s regime are not cost-free for us at home. The invasion of Ukraine presents a risk to our recovery as it does to countries around the world.” After the Spring Statement announcement, the chancellor has been criticised for failing to help those who are out of work and on lower incomes.

1.3 million could fall into poverty

The Chancellor’s Spring Statement on Wednesday has attempted to alleviate some of the pain from rising prices by providing some tax cuts, including a 5p-a-litre off fuel duty and a £3,000 increase in the limit for national insurance payments. However, it was criticised for failing to support poorer families and vulnerable groups from the rising cost of living. According to new analysis of Wednesday’s Spring Statement by the Resolution Foundation, around 1.3 million people will fall into absolute poverty in the next year. Typical working-age household incomes will drop by 4 per cent in real-terms next year (2022-23), a loss of £1,100. The poorest quarter of households could see their incomes drop by 6 per cent.

The Institute for Fiscal Studies noted that the Spring Statement omitted "anything for those subsisting on means-tested benefits", who will be dealing with the cost of living increases of about 10% "but their benefits will rise by just 3.1%." Paul Johnson, the Director of the institute told a news conference: "His choice to increase national insurance rates and reduce the basic rate of income tax looks, to me at least, indefensible from an economic point of view - though one can see the political attractions."

Ukraine

The pound has been very sensitive to news regarding the war in Ukraine but hopes for a ceasefire have helped markets recover. Investors have also come to terms with the situation and do not expect a further escalation.

The pound is forecast to continue to strengthen as the situation in Ukraine improves, but any unpredictable turn of events could create currency volatility.  

Energy prices and the currency market

Oil prices have been surging and this creates more risks to global economic growth and increases volatility. Currencies such as the pound and euro, for example, that belong to countries that are net importers of energy have been especially sensitive when energy prices rose. On the other hand, currencies such as the Australian, New Zealand and Canadian dollars which belong to countries that are energy and commodity exporters have strengthened. Safe-haven currencies like the Swiss franc and US dollar have also strengthened.

According to Barclays’ research, the UK is the most energy sufficient currency out of the G10 currencies as it produces 71% of its primary energy consumption needs, with over 80% of the UK’s natural gas imports coming from Norway, and only 15% from Russia. While it is affected by the surge in energy prices, it is not as much affected as other European countries. The OBR said that “higher global energy prices will weigh heavily on a UK economy that has only just recovered its pre-pandemic level.”

Rishi Sunak has pointed out that the Government could intervene on energy bills before the autumn if bills rise sharply again in October. He told BBC Radio 4’s Today programme: “Yes, of course we’ll have to see where we are by the autumn and it’s right for people to recognise that they are protected between now and the autumn because of the price cap.” He added: “I always keep everything under review, and the Government, as it’s shown over the past two years, is always responsive to what’s happening. But I would say with energy prices, you know, they are very volatile, and I don’t think you, I or anyone else has any certainty about what will happen in October right now.”

BoE and interest rates

The ongoing rise in inflation could push the BoE to raise interest rates further, however, the Bank could also exercise some caution as higher rates could slow down economic growth. The currency market is currently pricing in up to 130 points of rate hikes in 2022, but some analysts say the Bank will fail to meet market expectations.

If rate expectations continue, then the pound will remain supported but if any such expectations are cut then the pound will fall. Some analysts have noted that the pound could go lower against the euro if the market raises its bets that the European Central Bank (ECB) will tighten policy at the end of 2022.

 

Higher-than-expected inflation has helped the pound rise against the US dollar, as markets expect the Bank of England to proceed with further interest rate hikes.

According to the Office for National Statistics, UK CPI inflation rose 6.2% year-on-year in February, more than the 5.9% increase markets were expecting and higher than the 5.5% reported in January. Core inflation rose 5.2% in February, more than January's 4.4% figure. As a result, prices for goods rose, including those for food and games.

UK inflation

UK inflation has surged to a new 30-year high as higher energy, fuel bills and food prices drove the worst cost of living squeeze in decades. That’s the highest inflation reading since March 1992, at a time when household budgets are coming under extreme pressure. Last week, the Bank of England predicted inflation could reach 8% in April and could even go as high as 10% in the autumn when the energy price cap rises again.

The news comes hours before Rishi Sunak presents his mini-budget, as he prepares a fresh package of measures to alleviate inflationary pressures on consumers. He is expected to promise “a faster-growing economy, the security of more resilient public finances, and security for working families as we help with the cost of living.”

Sunak has a difficult task, as with inflation so high, taxes rising next month, and benefits such as pensions rising by 3.1 per cent, household incomes will experience a sharp fall.

Jack Leslie, senior economist at the Resolution Foundation has said that the Chancellor will need to set out a bold response to the situation as “Another sharp rise in inflation last month offers a foretaste of the huge income squeeze coming this year, with inflation likely to hit at least 8 per cent this spring – which could be the highest it’s been in 40 years – along with a second spike this autumn.” Leslie noted that prolonged high inflation “is a complete disaster for living standards. It will mean pay packets continuing to shrink, along with vital income support such as Universal Credit and the State Pension. The Chancellor will need to set out a bold response to this cost of living crisis in his Spring Statement today, starting with ensuring that benefits keep pace with inflation over the coming 12 months, rather than shrink by £10 billion as they are currently on course to do.”

Bank of England rate hikes

Markets have raised their expectations this week for the number of Bank of England rate hikes that are likely to be delivered in 2022, pushing the value of the pound higher. If this continues, then the pound will go higher.

Economists are concerned that inflationary pressures will continue to persist and increase, adding more pressure to the Bank to act.

Pantheon Macroeconomics has reported that higher inflation will stall UK economic recovery as households’ spending power shrinks. Chief U.K. Economist at Pantheon Macroeconomics Samuel Tombs expects the BoE to stop raising interest rates once the Bank Rate is 1.00% in May as further rate hikes will increase the risk of economic recession. The market has priced in up to 138 points of rate hikes for 2022 which means there is room for disappointment if the Bank pauses hiking rates which could also push the pound lower.

 

 

The pound is lower against both the euro and the US dollar following a stronger US dollar, as well as geopolitical and Brexit concerns. The main highlight for the week in terms of UK data will be the important inflation report this Wednesday which could support a Bank of England rate hike. With developments around Ukraine and January’s inflation data on the horizon, the pound could potentially be at risk. On Monday, rising fears of an imminent Russian attack on Ukraine triggered a global share sell-off and pushed oil prices higher.

Brexit

UK Foreign Secretary Lizz Truss has been criticised for granting too much ground to the EU in the ongoing negotiations over the Northern Ireland Protocol. In the latest round of talks, the Foreign Secretary is reported to have hinted that Britain would accept customs controls on goods intended for sale only in Northern Ireland. According to the Financial Times, the verbal offer was “so sensitive” it has not yet been put to paper. Truss’s latest concession about accepting some checks on trade within the UK contradicts the Government’s former position.

Pro-Brexit businessman and former MEP Ben Habib said that Truss’s suggestion represented a “complete collapse” in the Government’s position. Habib said: “If true, Ms Truss’s latest concession to the EU, to accept limited customs checks for goods from GB destined for use in Northern Ireland is a disaster.” He added: “It would signify a complete collapse in the British position and a preparedness to set in stone customs checks across the Irish Sea. Customs checks which the Government itself decried in its Command Paper last July.” The news, concerns over the Northern Ireland (NI) border checks and the lack of progress in the talks could weigh on GBP/USD prices.

PM Boris Johnson

Scotland Yard are in the process of contacting more than 50 people who have been present in the lockdown events in Downing Street. Boris Johnson has been contacted by the Metropolitan Police as part of the probe into lockdown parties held in Downing Street and across Whitehall. The formal questionnaire is understood to have been received after 9.30pm on Friday night. This could also add to political fears and weigh on GBP/USD prices.

Covid-19 and “Deltacron”

Another potential risk for the pound is news that health officials in the United Kingdom have begun monitoring a hybrid strain of the delta and omicron coronavirus known as "Deltacron" last week. While initially the mutation was dismissed, officials are now considering it as a real threat.  

Russia Ukraine tensions

Tensions between the two countries are high, with Washington warning that Russia could attack Ukraine at any time. Moscow has amassed more than 100,000 troops near Ukraine’s borders, while a senior Russian military official said on Monday that Russia was ready to open fire on foreign ships and submarines that enter its territorial waters.

BoE rate hike

The Bank of England will raise interest rates faster than previously expected to control surging inflation, according to economists polled by Reuters.

Sterling could rise on Wednesday when we get the release of inflation figures for January. Market participants expect a surprise on the upside and a more aggressive interest rate response from the Bank of England (BoE) over the coming months. CPI inflation is forecast at 5.4%, but investors have said a pleasant surprise on the upside could be a possibility.

Want to book your ideal rate? If you are a business transferring funds overseas, contacting a currency specialist could save you time and money. Universal Partners FX and their dedicated team can offer valuable insights into the market ahead of your currency exchange. If you are transferring funds to pay your employees abroad, get in touch with Universal Partners FX to find out how much you can save in your international money transfers. Universal Partners FX can provide invaluable help, efficient risk management and tailored solutions to your business’ transfer needs.

 

 

 

Sterling fell slightly lower on Wednesday but stabilised following comments by the Bank of England Chief Economist Huw Pill. Pill hinted that the Central Bank will take time starting active QE sales and he cautioned against an “aggressive” approach to rate rises. He argued that a case can be made for a measured approach to policy decisions.

Huw Pill

Bank of England Chief Economist Huw Pill has disappointed market expectations that the Central Bank will quickly begin active bond sales from its quantitative-easing program once interest rates hit 1%.

Speaking to the Society of Professional Economists on Wednesday, Huw Pill explained that letting the base rate remain at 0.5 percent would leave inflation above the Bank's target of two percent. He explained: "Following the market-implied path to 1.2 percent by the end of this year would have left inflation somewhat below target. I leave it to you to draw any implications for where the MPC sees the path of Bank Rate headed."

He said that “financial markets have come to expect a lot of guidance from Central Banks on where rates are heading.” But as we move back to a more normal monetary policy situation, Pill recognised that it was natural for the Central Bank to withdraw from detailed guidance. He added: "I am not going to give any specific view of what the yield curve should look like. It does not make sense to pre-empt market pricing judgements."

BoE's Pill: “Steady handed approach to monetary policy”

Pill cautioned that the Bank "Must focus on more persistent developments in the data that have lasting implications for the outlook for price stability." He explained that this is what he “would label a ‘steady handed’ approach to monetary policy." It is "Better to adopt a more measured and data-dependent approach, which learns from how the economy responds to each step taken rather than pre-commits to a concept surrounded by uncertainty," he said.

Pill defended the Bank’s approach and said that since September, it “has consistent, measured and resolute set of actions intended to rebalance the stance of monetary policy and address the inflationary pressures." He also said that they have indeed “signalled that more is to come in the coming months if the path sketched out in our February forecast plays out." However, he said that the Bank has also warned that the outlook for the bank rate in the coming months is uncertain due to the risks to inflation.

Bank rate decision

The decision to vote for 25 bp hike rather than 50 bp decision “was finely balanced” for Pill, as he noted, and that he was sceptical “of efforts to return the Bank rate quickly to some pre-defined neutral level or terminal rate." As he clarified, "Such an approach risks increasing inflation and output volatility if the policy is miscalibrated."

He admitted that due to the current inflationary pressures he could definitely understand why his colleagues on the MPC voted for a 50bp hike last week. He also noted that he would not want to rule out changes in the bank rate of more than the usual 25bp. He said: "Restricting ourselves to a 25bp now – albeit with the prospect of more to come in the coming months – is an investment in containing market expectations of aggressive activism."

 

Inflation concerns

A key concern for the Bank is that inflation will become entrenched as firms increase prices to respond to rising costs and workers demand higher wages to deal with the cost-of-living squeeze. Bank of England Governor Andrew Bailey was criticised last week after suggesting that workers should not demand big wage rises. Pill warned that if these second-round effects of inflation weren't restricted "a further monetary policy response would be required."

Inflation has been rising steadily and the Bank avoided raising interest rates until December as it was concerned about the health of the jobs market following the end of the furlough scheme. The jobs market has remained tight than previously expected in November, but with a high number of vacancies and staff shortages.

Last week's rate hike marked the first time the base rate had been raised in two consecutive meetings since 2004. Markets are currently pricing in several interest rate hikes and are forecasting interest rates to rise to 1.25 percent by December.

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The pound is expected to remain supported by market expectations of further interest rate hikes, according to analysts. The prospect of a much stronger euro is although questionable, as it is believed that the euro rally following last week's European Central Bank comments has possibly run out of steam.

The pound rallied against the euro and reached its highest level in two years last Thursday after the Bank of England raised interest rates, but those gains were soon erased by the Governor Andrew Bailey’s cautious tone and warnings about slowing domestic growth.

Sterling to remain supported

However, analysts have stressed that the Bank’s determination to hike rates to control inflation and the fact that it has overdelivered in the last two meetings, should keep further rate expectations high and sterling supported. Barclays forecast that the Bank will hike 25bp back-to-back in both March and May. Barclays also expect the pound to strengthen against the US dollar but drop against the euro by mid-2022.

It has also been argued by analysts that there are some factors that offer support to Sterling and suggest the economic outlook is not that negative. Paul Robson, Head of G10 FX Strategy, EMEA, at NatWest Market has mentioned that the January UK PMIs indicate a decent pick-up in activity in the last week of January, while the government’s announcement of fiscal measures will help to balance the cost-of-living rise. He also added that the removal of travel restrictions could support sectors of the economy that have been hit by the pandemic.

Concerns about the pound outlook

Analysts remain cautious about the pound’s appreciation and note that its gains might be limited due to the adverse economic background against which the BoE is tightening its monetary policy.

Additionally, the Bank’s hiking cycle is now fully price in by markets and any unexpected changes and disappointment could result in pound weakness.

ECB and interest rate hikes

Analysts have also pointed out that the market might be already pricing in too many interest rate hikes from the ECB. When last week the ECB said all members of the governing council were concerned about Eurozone inflation, markets understood that it might change its policy and start tightening monetary policy like other central banks. The market now expects two hikes, but for rates to be hiked in 2022, then the tapering of quantitative easing will have to accelerate, especially since  ECB President Christine Lagarde is resolute that the normal sequence of QE and then rate hikes will be followed.

Barclays have said that they now expect a March announcement of a faster tapering of asset purchase and 25bp rate hikes in both March and September 2023. Markets now expect the ECB to hike and tighten monetary policy much earlier than expected and closer to the US Federal Reserve and Bank of England. This scenario will be supportive of the euro.

On Monday, ECB President Christine Lagarde emphasised that Eurozone inflation risks are on the rise, but price pressures could still recede. She said: “Demand conditions in the euro area do not show the same signs of overheating that can be observed in other major economies.” She added: “This increases the likelihood that the current price pressures will subside before becoming entrenched, enabling us to deliver on our 2% target over the medium term.” Markets now price 50 basis points of rate hikes for 2022, but economists are more careful, with most forecasting the first one at the end of the year or early 2023. Of course, markets will gain more clarity as we move closer to the ECB's March policy meeting.

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The pound dropped against the euro last week but could slowly recover if the euro does not rise any further. Sterling rose sharply after the Bank of England’s Thursday decision to lift the Bank Rate from 0.25% to 0.50%, but experienced losses when Governor Andrew Bailey and other members of the Bank’s Monetary Policy Committee warned of risks to economic growth and that meeting market expectations for the Bank Rate could eventually lead inflation to fall below the Bank’s target level of 2%.

The forecast for inflation anticipates inflation to remain elevated above the Bank’s target for more than two years and to fall below 2% in 2025. This means that the Bank might avoid raising rates in 2023, despite market expectations.

Thursday’s European Central Bank (ECB) policy decision

Sterling fell due to the Bank of England’s cautious tone and concerns about the effects of the recent increase in energy and international traded goods prices. But it was the hawkish shift of the European Central Bank last Thursday that also deflated the pound and boosted the euro. The foreign exchange market moved sharply and resulted in the euro rising higher. After ECB president Christine Lagarde said that Eurozone inflation risks have increased, financial markets expectations for a potential end of negative interest rates rose. The euro rally could extend, and this will be an ongoing risk for the pound.

Rising inflation and cost of living squeeze

Economists have warned on Monday that inflation will hit UK economic growth this year as consumers have to deal with the rising cost of living.  In its latest quarterly assessment of the economy the EY Item Club has cut its forecast for UK economic growth this year to 4.9%, as the squeeze on households’ spending power and the omicron variant slow economic recovery. The EY predicts inflation to hit 7% in the spring and real wages to fall. They also expect the Bank of England to hike the Bank Rate to 1% by the end of this year.

Hywel Ball, EY’s UK chair, says: “The forecast shows that the economy’s bounce back in 2021 was stronger-than-expected and Omicron’s economic impact is likely to be temporary and limited. While the economy and UK businesses may have a softer launch pad for growth this year, they will still benefit from a number of tailwinds in 2022 and 2023. But blowing in the opposite direction will be a squeeze on household spending power which is expected to be a bigger headwind for the economy than the Omicron variant. Inflation is set to reach its highest level in thirty years by the spring and will be well ahead of pay growth. Although the latest forecast says that the economic scarring from the pandemic is likely to be minimal, policymakers still face the challenge of how they help support households through the forthcoming squeeze on their finances and give companies the confidence needed to unlock business investment. The push towards Net Zero certainly creates an opportunity for investment growth.”

What to watch this week

The pound will be sensitive to any comments made by BoE Chief Economist Huw Pill on Wednesday’s online event with the Society of Professional Economists and Governor Andrew Bailey on Thursday’s online event hosted by TheCityUK. Friday’s UK GDP figures for December and the final quarter will also reflect the effects of the Omicron variant on economic activity into the end of the year. The GDP is expected to have fallen by -0.5% in December and to have grown by 1.1% for the final quarter.

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The pound rose against the euro and the dollar after the Bank of England voted to raise interest rates to 0.5%. The Monetary Policy Committee (MPC) voted by a majority of 5-4 to increase the Bank Rate by 0.25%.

While Governor Andrew Bailey, deputy governors Ben Broadbent and Jon Cunliffe, chief economists Huw Pill and external member Silvana Tenreyro voted to raise the rate from 0.25% to 0.5%, deputy governor Dave Ramsden, and Catherine Mann, Jonathan Haskel and Michael Saunders all voted for a 0.75% increase. These four members argued that monetary policy should tighten faster, to “reduce the risk that recent trends in pay growth and inflation expectations became more firmly embedded.” This points that further hikes will be coming soon.

Inflation to rise above the Bank’s 2% target

The Bank of England has increased its inflation forecast and expects inflation to increase 7.25% in April. This is over three times higher than its 2% target and shows how difficult the cost of living squeeze will be.

The Bank said that energy bills will rise in April while goods prices will also continue to increase. The rise in inflation reflects this rise in global energy and tradable goods prices. Inflation will rise more in the coming months before peaking at around 7.25 in April.

Bank will start unwinding its £895bn stimulus package

The Committee voted collectively for the Bank of England to begin to reduce its £875bn stock of UK government bonds, by not buying new gilts when they mature. They also voted to reduce its £20bn stock of corporate bonds on its balance sheet, by not reinvesting maturing assets and by selling bonds.

Subdued growth

The Bank also warned that unemployment will rise, and growth will slow down, as the Omicron variant impacted on economic activity in December and January. While a recovery is expected in February and March, in the longer term, UK economic growth is “expected to slow to subdued rates.” Rising inflation will hit household incomes and spending and push up unemployment. The BoE explained: “The main reason for that is the adverse impact of higher global energy and tradable goods prices on UK real aggregate income and spending. As a result, the unemployment rate is expected to rise to 5% and excess supply builds to around 1% by the end of the forecast period.”

The Bank anticipates unemployment to fall further to 5% by the start of 2023.

Earning Squeeze

The Bank of England is concerned that UK families will suffer in terms of living standards as disposable incomes will shrink by 2% this year, and by another 0.5% in 2023. This is the biggest reduction since 1990.

Sky News’s Ed Conway said: “The fall - largely a consequence of higher energy bills but also the rising tax burden and comparatively weak earnings - is considerably bigger than 1.3% fall in 2011, up until now the biggest squeeze since the statistical series begin.”

As the governor of the Bank of England said, the “hard message” is that “we are facing a squeeze on real incomes.” So, this is why the Bank decided to raise interest rates, otherwise the effects will be much more damaging.

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The pound has risen to multi-year highs following buying interest ahead of the Bank of England’s rate hike decision on Thursday (3rd February). Economists are warning that the pound could later in the year fall under pressure following economic disappointment.

Sterling recorded gains against both the euro and the US dollar as investors anticipate a second Bank of England interest rate that would possibly take the Bank Rate to 0.50%.

Bank of England

Market expectations for higher interest rates show that investors believe that inflation will remain high above the Bank’s target of 2% for a longer period of time. This will encourage the Bank to proceed to further interest rate hikes as the economy is recovering and has shown signs of resilience despite the spread of the Omicron variant. The UK economy has strongly bounced back compared to other major economies.

UK economy

The UK economy shrank during the months of December and January but is expected to rebound in February, according to economists. With restrictions lifted and less employees self-isolating, businesses will slowly return to normal and consumer confidence will rise.

If such expectations are justified and the economy is proven to be on the right track, then the Bank could raise interest rates in February and signal even further hikes in the coming months.

Thursday’s Bank of England meeting will be closely watched by investors for any indications that the Bank will proceed to a faster monetary policy normalisation which could provide support to the pound.

MUFG's Head of Research Derek Halpenny said that the Bank of England will prefer a “more front-loaded” action “with an additional 25bp hike in May helping support GBP versus the euro but later in the year risks of slower growth could push the BoE to the sidelines and result in the pound reversing versus the euro.” Other economists have also warned of slower economic growth later in the year as consumer spending is limited by increased inflation and tax rises, which could push the Bank to abstain from raising interest rates.

Comments from the Bank’s Monetary Policy Committee member Catherine Mann also suggest that it is better to act early rather than to proceed to a high “terminal” Bank Rate later, as to provide support to businesses and act on inflation.

Inflationary pressures

Workers and consumers will experience a loss of earning power as inflation rises and exceeds 7.0% in the first half of the year. Utility bills are expected to rise in April too, putting more pressure on households. The introduction in April of a hike to employee and employer National Insurance and the fact that income tax bands will be frozen, will result in households paying higher taxes.

Economists have also noted that both the euro and the US dollar will face challenges ahead, with the dollar’s rally to end this year. The US dollar dominance has been priced in as the Fed now seems ready to deliver up to 7 rate hikes this year, which means the greenback might start seeing some underperformance against advanced economies that become more aggressive in tightening their policies.

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