The Bank of England (BoE) hiked interest rates by 25 bps to 1.25% yesterday as was widely expected. The pound first declined but then rose when the market digested the MPC statement about acting “forcefully” to adjust monetary policy.

While some economists have warned that the pound could remain subdued, others believe it can rise if it continues to hold on its recent gains.

BoE’s announcement

The Bank anticipates the economy to slow down and shrink in the second quarter while rising household energy bills will push inflation above 11% in October.

Three out of the nine Monetary Policy Committee (MPC) members supported a higher interest rate hike of 50 bps as persistent and higher inflation continues and central banks around the world are determined to curb inflation and hike aggressively. The US Federal Reserve announced a 75-point rate rise on Wednesday, which marks the largest single rate rise since 1994.

Inflationary pressures

Stock markets fell on Thursday as investors worried that rising interest rates would slow down growth and lead to recession, with the FTSE falling 3.14% to a three-month low.

Following Switzerland’s central bank unexpected rate rise, European shares also fell, and bonds prices dropped, while the S&P 500 was lower at around 3%.

Responding to the rising cost of living and Russia’s war in Ukraine which has exacerbated global energy prices, the MPC said it was prepared to bring inflation closer to its target rate of 2% and if necessary “act forcefully in response.”

UK economic concerns

The Bank of England’s decision to limit its interest rate rise to a 0.25-point increase highlights its concerns over economic growth after recent disappointing growth readings, the cost-of-living crisis, the limited spending power of struggling households and businesses facing staff shortages and supply chain issues. The risk of recession has also led the Bank to downgrade its growth forecast for the second quarter of the year. The UK economy shrank unexpectedly in April after a fall in March.

British households are currently struggling with a surge in living costs as inflation reached 9% in April. While Rishi Sunak’s £15bn package will provide support to the economy, the BoE warned that it would also add 0.1 percentage points to inflation within the first year as it would boost strong consumer demand for goods and services.

The Bank of England’s governor Andrew Bailey said further rises in household energy bills expected this October would push inflation above 11% in October. In a letter to the chancellor, he said a “succession of global shocks” were affecting the economy and that “The MPC will take the actions necessary to return inflation to the 2% target sustainably in the medium term.

In terms of the pound’s performance, at least in the near term, it appears that the pound will struggle to hold on tight to its recent gains as investors reassess the BoE’s gradual approach to policy tightening.

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