As such, the BoE still finds itself at somewhat of a crossroads.
On the one hand, it could pause its hiking cycle in the hope that inflation has peaked to boost growth, and protect the banks. Some economists predict that interest rates will peak 25bp lower than the market expectation at 4.25 per cent. That makes sense and a 4.5 per cent peak looks ambitious.
In this instance, the delayed effects of tightening could encourage the MPC to cut rates by 25bp in the fourth quarter. On the other hand, it may try to grind inflation into the ground and raise interest rates hawkishly.
For the longer-term health of the economy, historically speaking, this is the best thing to do. This sentiment was echoed by BoE policymaker Catherine Mann recently, when she argued that “material upside risks” remain for sticky inflation. However, it is a bitter pill to swallow and could result in a deep recession.
What is certain is that the MPC will want to see inflation’s downward trend continue before it hits pause on the hiking cycle. Everything hinges on whether vacancies carry on dipping, wage data starts to cool, and energy prices begin falling.
However, perhaps the weakness of the banking system and the need to protect it will now replace inflation as the main priority for the BoE, and indeed the other central banks around the world. With inflation on the run, the MPC will want to ensure that they do not take their foot off the brake too early.
But, by pausing now, the BoE can allow the UK’s financial system adjust to the ‘new normal’ of higher rates and recover from the turmoil faced by other banks in the last few weeks, delivering some much-needed stability amidst the cost-of-living crisis.
As a result, the markets have priced in an almost equal probability between a 0.25bps increase and no change, indicating how much of a difficult decision the MPC have to make on Thursday.
Opportunities for investors
Across the pond, the SVB crisis will perhaps have a more significant impact on central bank policy than in the UK. Indeed, despite policymakers at the Federal Reserve hinting that they will need to keep gradually raising interest rates to combat inflation effectively just weeks ago, inflation has cooled further and turmoil has ravaged the banking system.
As such, the probability of the Fed raising rates further fell close to zero last week, but expectations continue to shift rapidly. For currency investors, a Fed pause could see strength for GBP in the short-term, so should be monitored closely when the FOMC meets on Tuesday and Wednesday.
In terms of the other major central banks, such as the European Central Bank (ECB) – whose economy is perhaps more resilient in the face of the cost of living crisis – it is likely that rates will rise again at their next meetings (perhaps even the Bank of Japan, which has held firm to an ultra-loose monetary policy up until now, is looking to slowly transition to interest rate normalisation).
