The BoE said more interest rate hikes were needed as inflation is harder to control

The Bank of England (BoE) is being warned that it may have to raise interest rates more than investors expected, even as recession risk rises, in part because it has lost a large chunk of its power to control inflation.
Karen Ward, a former UK Treasury adviser, said the traditional transmission mechanism by which rate hikes tame price growth has been weakened by the huge accumulation of savings during the pandemic and the rush to maintain low mortgage rates for long periods.
As a result, consumer spending should remain more resilient and inflation more persistent than the BoE expects, as “the household sector has become much less interest rate sensitive than before,” Ward said. Chief Market Strategist for Europe at JPMorgan Asset Management. said in an interview.
Ward sounded the alarm the same week former central bankers Adam Posen, Charles Goodhart and Kristin Forbes all said the BoE will have to keep raising borrowing costs despite the economy’s unexpected contraction in March.
All told lawmakers that soaring inflation meant the BoE would eventually raise its benchmark to at least 3%, with Goodhart saying it may have to go as high as 5% – a level last seen in 2008. This compares to the current rate of 1% and the market is betting that the top will be 2.5%.
In contrast, former government adviser Rupert Harrison, now at BlackRock Inc, said Thursday that Governor Andrew Bailey and his colleagues should pause their rate hike campaign and advised Chancellor of the Exchequer Rishi Sunak to provide more support for low-income households and to consider temporarily reducing the sales tax.
Bloomberg Economics also expects the BoE to halt tightening in June after four straight hikes.
Yet households have three times more savings on deposit than floating interest rate mortgages, suggesting that higher rates create more purchasing power through the savings channel than they do. gain by increasing debt service costs.
The imbalance has not been so marked in 15 years since the BoE has been collecting granular mortgage data. In a February post, the central bank admitted that the change meant that “the impact on net incomes of a rise in the bank rate could be somewhat lower than before the financial crisis.”
In an interview with Bloomberg News this week, BoE Deputy Governor for Markets Dave Ramsden said monetary policy “is still fit for purpose, but it may take a little longer.” He added that commercial banks were more likely to pass on rate hikes to mortgages than to deposits.
Household balance sheets have changed over the past decade. Lockdowns during the pandemic have resulted in an accumulation of around £200bn in excess savings, none of which has been spent. At the same time, there have been dramatic changes in home ownership.
Only 30% of households now have a mortgage. Four out of five home loans are fixed term and half have been tied for five years. As a result, rate hikes have an immediate impact on less than 2 million households, or just 6% of the total in the UK. In 2007, 16% would have been concerned.
The BoE’s February analysis showed that it will take nearly three years for a rate hike today to have the same immediate impact on households as in 2007.
“There was already a question of whether spending would prove more resilient as people dipped into their lockdown savings,” Ward said.
“If people earn more interest on these savings, it will only create a greater propensity to spend. This suggests that demand will be more resilient and rates will need to go higher than expected and stay there. It could be 3%.”
“This deep-rooted pessimism that the economy cannot cope with 2.5% rates is wrong.” The BoE believes that less direct mechanisms than savings and mortgages, such as exchange rates, will continue to prove effective. However, the pound has fallen this year against a trade-weighted basket of currencies, making imports more expensive.

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