The BOE rate pivot sends a signal to ECB

Winston Churchill’s words at the turning point of World War II in 1942 are an apt summary of where the Bank of England currently finds itself: “Now this is not the end. It is not even the beginning of the end. But it is, perhaps, the end of the beginning.” And while the Federal Reserve remains committed to pushing borrowing costs higher than traders are anticipating, the European Central Bank is rapidly heading to the same point as its UK peer.
If ever there was a dovish 75 basis-point hike to interest rates, then the BOE has delivered it. By raising its official rate to 3% at the same time as explicitly signaling that it expects rates to peak some way below current market pricing, it has set itself apart from the other major central banks.
Sterling fell 2% against the dollar, an odd response, perhaps, to the largest single rate increase in more than 30 years. But the backdrop is that Fed Chair Jerome Powell struck a notably more hawkish tone after US rates were also increased by three-quarters of a point hike last week. While it is not immune from the global slowdown, the US economy is in a far more secure place, with labor market tightness paramount in the Fed’s mindset. The Fed’s revised monetary policy mantra might now be slower, longer, higher. The BOE’s is definitely slower, but also shorter and ultimately lower, too.
There will be further rate hikes from the BOE, but a repeat of 75 basis points is highly unlikely. Deputy Governor Ben Broadbent had flagged this shift in approach in a speech on Oct. 20, but it has now become official policy. Two members of the Monetary Policy Committee dissented, calling for a more modest move.
The era of oversized rate hikes is over in the UK and elsewhere. Central bankers in Canada, Australia and Norway all tightened policy by less than expected in recent weeks, with all three countries facing fragile housing markets. Keeping up with the Fed is losing its appeal; both the euro and pound lost ground versus the dollar after recent rate increases because growth expectations are starting to matter more than interest-rate differentials. “During the years when inflation was depressed, raising rates was almost always currency friendly,” says Kit Juckes, currency strategist at Societe Generale SA. “But we’re in a new policy paradigm and hiking into an economic downturn isn’t necessarily currency friendly.” Pay attention, ECB.
The BOE knows it has an inflation problem now, but it will soon be a contracting economy and rising unemployment that take priority. Governor Andrew Bailey remarked that the UK is suffering a bigger income shock even than the 1970s, and that the BOE is looking through a different lens from the Fed.
—Bloomberg