Bond Watch: hawkish Bank of England hold amid inflation fears

The Bank of England’s Monetary Policy Committee (MPC) voted 8–1 to maintain interest rates at 4.5% this week, as it grapples with rising inflation. One member voted to cut interest rates 0.25 percentage points.

Twelve-month CPI inflation increased to 3% in January from 2.5% in December. The Bank of England expects CPI inflation to rise further in the near term, to around 3.75% in the third quarter of the year. 

It said that this was similar to its forecast delivered in February, with higher non-energy inflation offset by lower energy prices.

• Invest with ii: Open a Stocks & Shares ISA | ISA Investment Ideas | Transfer a Stocks & Shares ISA

The Bank fears that cutting interest rates too quickly could lead to higher inflation. On the other hand, cutting too slowly – or not at all – could slow down the economy too much.

• How investors can hedge against Trump’s trade wars
• Benstead on Bonds: in a worst-case scenario, can gilts deliver?

The central bank is “crippled by uncertainty” according to Hussain Mehdi of HSBC Asset Management.

“A stagflationary tone to recent economic data means the MPC is balancing inflation considerations against downside growth risks and fragile confidence. For now, it seems the inflation side of the debate is dominant, reflected in just one MPC member voting to cut,” he said.

Sanjay Raja, Deutsche Bank’s chief UK economist, says that the decision highlights growing concern around the pace of disinflation progress in the midst of growing uncertainty. 

He makes three points:

1)  The vote count was more hawkish than expected, with just one member looking to cut interest rates

2) The MPC did not change its guidance, sticking with its message delivered at the last meeting that “a gradual and careful approach to the further withdrawal of monetary policy restraint was appropriate”.

3) There is increasing concern around the near-term inflation outlook, including the persistence of supply-led inflationary pressures. Therefore the Bank of England said it could be more flexible.

Deutsche Bank thinks that interest rates could be 3.25% early next year.

• DIY Investor Diary: I invest so I don't have to worry about money
• ISA ideas: where should contrarians look for opportunities?

No rate change in the United States either

The US Federal Reserve also left rates unchanged this week, at between 4.25% and 4.5%, while indicating that two 0.25 point cuts could be delivered this year.

Like in the UK, its central bankers said that the outlook was uncertain this year, as tariffs affect supply chains and inflation.

Tiffany Wilding, economist at Pimco, says: “Higher inflation forecasts, coupled with lower growth forecasts, likely reflect changing assumptions around government trade policy and higher expected tariff rates.”

She adds that Federal Reserve officials are facing the challenge of balancing rising inflation and recession risks that appear to be rising in tandem.

In the near term, Wilding says that Fed chair Jerome Powell signalled that officials are comfortable keeping rates on hold and proceeding cautiously.

“However, we think unemployment will be the ultimate arbiter, and still expect the Fed to cut aggressively in the event that the unemployment rate starts to move higher,” she adds.