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BoE’s Broadbent: Interest rates may not rise as much as market expects
Just in. Bank of England deputy governor Ben Broadbent has said it ‘remains to be seen’ whether UK interest rates have to rise as much as the markets predict.
That could bring some relief to mortgage-holders, who are concerned that interest rates are currently forecast to more than double to over 5% by next summer.
Speaking at Imperial College London, Broadbent explains that the economy has been hit by severe real shocks.
The pandemic raised the global demand for goods and reduced their supply; Russia has cut back severely its supply of gas to Europe. These have had dramatic effects on relative prices.
In particular, import prices have risen significantly compared with the price of UK output. This has unavoidably depressed real incomes: the volume of output may have just about recovered to pre-Covid levels but its consumption value has not.
Broadbent also warned that the economy would suffer a hit if market bets about rising rates come to pass.
Broadbend explains that the Bank’s Monetary Policy Committee will respond promptly to news about fiscal policy (the MPC is due to set interest rates on November 3rd, three days after Jeremy Hunt is due to announce his fiscal plan).
Broadbent says the justification for tightening monetary policy is clear (inflation is five times over the Bank’s 2% target, for starters).
But much of the overshoot in inflation is due to higher import prices (such as gas, and food which has risen by over 14% in the last year). That effect should fade as prices stabilise.
Broadbent explains that the path of wholesale energy prices is highly uncertain, but financial markets suggest we’re more likely to see negative than positive inflation in wholesale gas prices a couple of years from now.
Domestic inflation tends to be persistent, however. And reducing it requires the economy to grow below its trend rate for a period of time, he warns.
Broadbent concludes:
Because they’ve depressed real incomes, that slowing in demand will to some degree follow from the very same rises in import costs that have pushed up headline inflation.
Equally, if government support mitigates that effect, there is more at the margin for monetary policy to do. The MPC is likely to respond relatively promptly to news about fiscal policy. Whether official interest rates have to rise by quite as much as currently priced in financial markets remains to be seen.
NEW: #BoE‘s Broadbent says the MPC is likely to respond promptly to news about fiscal policy; justification for tighter policy is clear; if govt supports mitigates the effect of import costs, there is more at the margin for monetary policy to do.
— Julianna Tatelbaum (@CNBCJulianna) October 20, 2022
NEW: #BoE‘s Broadbent says there is now some uncertainty about the prospective scale and nature of the govt’s energy subsidies; we are unlikely to know for a while precisely the form that will take.
— Julianna Tatelbaum (@CNBCJulianna) October 20, 2022
Key events
Filters BETA
The head of the CBI has warned that the UK’s growth engine is grinding to a halt in some places, as political instability leaves business owners confused and unwilling to invest.
Tony Danker (who once hailed the mini-budget as a ‘turning point’ for the economy*) says political and market stability is needed.
That means firms can grow, meaning more employment and tax revenues, and less need to slash public spending or hike taxes.
* – and in many ways it was, unfortunately.
Politics is falling apart somewhat. Let me set out why it matters. 1/8
— Tony Danker (@tonydanker) October 20, 2022
In 10 days, the country needs to decide to cut public services and/or raise everyone’s taxes. Probably both. The most important principle is protecting those in our society who need it most. That is fundamental. 2/8
— Tony Danker (@tonydanker) October 20, 2022
The only way to avoid this pain is to get more economic growth. Because if firms grow they pay more taxes, higher wages and create more jobs. More tax revenue means fewer cuts. 3/8
— Tony Danker (@tonydanker) October 20, 2022
Today, the UK’s growth engine – firms investing more in products, services and people – is coming to a halt in some places. Political instability makes business owners unsure – What will taxes be?What will regulations be? what will Government spend money on? What will be cut? 4/8
— Tony Danker (@tonydanker) October 20, 2022
Lots of businesses want to invest – they have the money and the plans – but by my estimates, about half of them won’t press the button until this political mess clears up and we have a clear government plan and market stability. 5/8
— Tony Danker (@tonydanker) October 20, 2022
Market stability matters because its affects interest rates. That matters to everyone’s bills and mortgages and it also hits businesses. Most firms in the country borrow money to invest so if interest rates rise too fast or high, they simply won’t invest. 6/8
— Tony Danker (@tonydanker) October 20, 2022
If we get political and market stability, there will be headspace and clarity for business owners to press go on plans. Then we need all those government enablers for growth to come on tap: immigration reform, a better planning regime, more clean energy projects etc. 7/8
— Tony Danker (@tonydanker) October 20, 2022
That’s why we will continue to push Government to both help the hardest hit and keep going on growth. It’s the only way to ensure that any spending cuts or tax rises are kept to a minimum. And any recession is short and shallow. And none of this is repeated. 8/8
— Tony Danker (@tonydanker) October 20, 2022
Here’s the Broadbent effect – market expectations for interest rate rises are down:
Back in the markets, UK government bond prices have also strengthened following Ben Broadbent’s speech.
The yields on two-year, 1o-year and 30-year bonds are all now down today, pushing down government borrowing costs.
Markets are react to the deputy governor’s warning that interest rate forecasts may be too high, and have reached levels that would deliver a “pretty material” hit to the economy.
In another worrying sign, more than a quarter of companies said their turnover decreased in September.
The Office for National Statistics (ONS) found 26% of trading businesses reported their turnover was lower compared with August 2022, while just 14% reported their turnover was higher.
The accommodation and food service activities industry saw the biggest drop-off, with 52% of businesses reporting a drop in turnover compared with August (when the summer holidays will have boosted some takings).
A quarter (25%) of businesses also reported their performance had decreased in September 2022 compared with September 2021.
Companies are also suffering from the economic and political turmoil.
In early October (shortly after the min-budget) more than a third of businesses reported economic uncertainty was having an impact on their turnover. A fifth expect their turnover to decrease in November 2022.
As we covered earlier, the UK hospitality sector is already shrinking at the fastest pace since the 2021 pandemic lockdown:
ONS: More firms running short of cash
Over 40 percent of UK firms have either no cash reserves left, or have less than three months worth to help them through the downturn.
That’s the worst situation since June last year, the Office for National Statistics reports:
In early Oct 2022, 41% of trading businesses said they had either:
▪️ no cash reserves (13%)
▪️ had three months or less (28%)This is the highest percentage reported since late June 2021. pic.twitter.com/Sh6JJRTOxw
— Office for National Statistics (ONS) (@ONS) October 20, 2022
The situation is particularly tight in the education industry, where 51% of private sector and higher education businesses have less than three months cash left.
The administrative and support service activities industry reported the largest increase in the proportion of businesses reporting having no cash reserves or three months or less, up to 44% from 35% reported in early July.
This is an important intervention by Ben Broadbent, says Chris Giles of the Financial Times.
He reckons that if the markets take the deputy governor seriously, we’ll see a fall in expected bank rate.
That could leading to lower debt interest service costs for the government – in time to shrink the fiscal ‘black hole’ facing Jeremy Hunt, and also lower mortgages rates in a few days time.
Important Speech by @bankofengland Ben Broadbent
More directly saying financial markets are pricing in too many rate rises than I’ve ever heard before from an MPC member
This is the key chart – how much markets have moved and internal BoE modelling on what it thinks necessary pic.twitter.com/NcuCntAw2k
— Chris Giles (@ChrisGiles_) October 20, 2022
Broadbent says you need to take the chart with a “heavy dose of salt”
But officials don’t make comparisons like these on a whim – they don’t even recognise externally that this analysis exists within the BoE
Of course we all knew it did and should have been routinely published
— Chris Giles (@ChrisGiles_) October 20, 2022
The consequence – if markets respond with lower expected bank rate – lower debt interest service cost for government in the medium term fiscal statement – (so fewer tax increases)
And cheaper mortgages in a few days time.
All if markets take the dep gov’s words seriously
— Chris Giles (@ChrisGiles_) October 20, 2022
Ben Broadbent has also produced a fascinating chart, showing how market interest rates have risen much higher than the Bank of England’s internal modelling suggests is necessary.
The barchart is the “optimum” level of rate increases you’d expect given the energy support package and the fall in sterling, while the blue line shows the actual, rather higher, rise in yields.
Broadbent says we should treat this with some scepticism, as it uses a simple policymaking “bot” to work out the optimal rate path.
Plus, there are other factors at work – including political uncertainty (that ‘moron risk premium’ we looked at earlier).
Or as Broadbent puts it more diplomatically:
The market may also be wary about further changes in fiscal policy, and to take a skewed view of the risks in that respect.
Ben Broadbent’s speech shows that Bank of England are cautious about how fast to raise interest rates, with the economy weakening.
Here’s Bloomberg’s take:
Bank of England Deputy Governor Ben Broadbent said it’s not clear that UK interest rates need to rise as much as investors expect and warned about a hit to the economy if markets bets come to pass.
While “the justification for tighter policy is clear” in the face of soaring inflation, demand will slow to some extent anyway along with higher prices, Broadbent said in the text of a speech on Thursday. If rates follow the current path, it could cause a 5% hit to GDP, he said.
The remarks indicate caution at the BOE about how quickly to tighten monetary policy as the risk grows that the UK has already slipped into recession.
It also feeds into a tumultuous few weeks for the central bank and the outlook for the economy after Prime Minister Liz Truss’s government first announced a huge fiscal stimulus on Sept. 23 and then subsequently unwound much of the program.
Ben Broadbent also warned that achieving a ‘soft landing’ in the UK economy will be difficult.
He explained that the UK’s terms-of-trade shock is far more severe than in the US, where the Federal Reserve is also struggling to get inflation down without pushing America into recession.
Ben Broadbent’s speech, on the inflationary consequences of real shocks, is online here.
It’s about 20 pages long – but the conclusion is that the markets may have overestimated how high interest rates will rise, points out economics writer Duncan Weldon:
Lifting rates over 5% by next summer would certainly be hawkish, given the UK could be in recession by then.
Broadbent also points out that we’ve barely seen much of the impact of tighter policy that is being priced in, and which will have a big hit to demand:
Markets lower rate hike bets
The financial markets are dialling back their forecasts for November’s interest rate rise.
They now indicate there’s an 85% chance that the Bank raises rates to 3% on 3rd November, from 2.25% today, which would be a three quarter-point rise.
A full percentage point rise, to 3.25%, is only a 15% chance. Before Ben Broadbent’s speech, it was a 25% probability, according to Reuters.
Interest rate expectations surged after the mini-budget rocked markets, but have been falling back after the government began ditching the plan.
At one stage after the mini-budget, the markets thought the Bank would choose between a 1% increase, and a monster 1.25% hike.
But even a three-quarter point increase would be the largest rise in UK Bank Rate in 33 years, putting more pressure on borrowers, and meaning remortgaging will be expensive.
BoE’s Broadbent: Interest rates may not rise as much as market expects
Just in. Bank of England deputy governor Ben Broadbent has said it ‘remains to be seen’ whether UK interest rates have to rise as much as the markets predict.
That could bring some relief to mortgage-holders, who are concerned that interest rates are currently forecast to more than double to over 5% by next summer.
Speaking at Imperial College London, Broadbent explains that the economy has been hit by severe real shocks.
The pandemic raised the global demand for goods and reduced their supply; Russia has cut back severely its supply of gas to Europe. These have had dramatic effects on relative prices.
In particular, import prices have risen significantly compared with the price of UK output. This has unavoidably depressed real incomes: the volume of output may have just about recovered to pre-Covid levels but its consumption value has not.
Broadbent also warned that the economy would suffer a hit if market bets about rising rates come to pass.
Broadbend explains that the Bank’s Monetary Policy Committee will respond promptly to news about fiscal policy (the MPC is due to set interest rates on November 3rd, three days after Jeremy Hunt is due to announce his fiscal plan).
Broadbent says the justification for tightening monetary policy is clear (inflation is five times over the Bank’s 2% target, for starters).
But much of the overshoot in inflation is due to higher import prices (such as gas, and food which has risen by over 14% in the last year). That effect should fade as prices stabilise.
Broadbent explains that the path of wholesale energy prices is highly uncertain, but financial markets suggest we’re more likely to see negative than positive inflation in wholesale gas prices a couple of years from now.
Domestic inflation tends to be persistent, however. And reducing it requires the economy to grow below its trend rate for a period of time, he warns.
Broadbent concludes:
Because they’ve depressed real incomes, that slowing in demand will to some degree follow from the very same rises in import costs that have pushed up headline inflation.
Equally, if government support mitigates that effect, there is more at the margin for monetary policy to do. The MPC is likely to respond relatively promptly to news about fiscal policy. Whether official interest rates have to rise by quite as much as currently priced in financial markets remains to be seen.
NEW: #BoE‘s Broadbent says the MPC is likely to respond promptly to news about fiscal policy; justification for tighter policy is clear; if govt supports mitigates the effect of import costs, there is more at the margin for monetary policy to do.
— Julianna Tatelbaum (@CNBCJulianna) October 20, 2022
NEW: #BoE‘s Broadbent says there is now some uncertainty about the prospective scale and nature of the govt’s energy subsidies; we are unlikely to know for a while precisely the form that will take.
— Julianna Tatelbaum (@CNBCJulianna) October 20, 2022
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