‘UK rate hike only tool for the BoE’

(Video Transcript)

Are we in for a BoE surprise?

AO: Hello, I'm Angeline Ong and welcome to IG's Trading the Markets. Here to discuss the state of the UK economy ahead of the Bank of England (BoE) rate decision is Dewi John, Head of Research, UK and Ireland Lipper LSEG. Thank you so much for joining us, Dewi.

All the talk in the city is there's this expectation of a rate hike later this week. However, this is quite a blunt tool and, also, are there likely to be any surprises for you? Are you looking out for any surprises?

DJ: Always expect the unexpected, yeah. You're right, it's a blunt tool. Consensus is 25 basis points. That seems quite likely.

We all understand the fears, but it's the only tool that the bank's got, but it's the wrong one because we all know that quote from Ben Bernanke (former Fed chairman from 2006 to 2014), quoting his predecessor William McChesney Martin, (Fed chairman from 1951 to 1970), that the job of a central bank is to take the punchbowl away before the party gets into full swing.

This is certainly no party

Well, if this is a party, I want to get the cab home as soon as possible. It's insipid growth, the economy is fairly weak and obviously we're all worried about the effects that the rate rises will have. On the flip side, inflation has proved much stickier than markets expected, so the bank has to be seen to do something, even if that something is the only thing that it can do.

AO: Do you personally think the BoE should push forward with another rate hike?

DJ: Personally, I am in the sceptical camp and the reason is that rate rises are supposed to damp down on excessive demand. If you take apart the composition of inflation figures, only some of this is down to demand. A lot of it, depending on the analysis you look at, but let's say about 50% is down to supply constraints and the bank will have very, rate rises will have very little effect on that.

AO: Surely, Dewi, there are other effects of a rate hike, of course, it can also boost sterling. What do you think this is going to do in terms of inflation and, of course, the wider UK economy?

Rate hike may not help UK economy

DJ: Well, the UK, as you know, is a very import-dependent economy, particularly on goods and energy. And the one case I can see that's fairly strong for a rate hike is in that sense, because we're running more or less neck-and-neck with the Fed, there's the danger that the European Central Bank (ECB) will catch up.

So if we want to strengthen sterling, yes, there is a case for that. But the flip side is what that will do to the broader economy and that's looking very dicey at the moment.

AO: And based on all this, there is a clear concern that if the Bank of England does go ahead with this hike, companies are already saying that they have seen a long run of tightness in borrowing and also consumers starting to show those cracks, right?

DJ: Many people are starting, if we look at data points, to change down to cheaper brands, credit is tightening. Those people paying off the credit, they're starting to go from one month late repayment to three months' late repayment.

AO: Are we going to push the economy too far? Is the Bank of England going to essentially keep rates so high that it really starts permanently siphoning the UK economy?

Inflation could lead to debt 'death spiral'

Well, I think what it's hoping to do is, if it does carry through this rate rise, that it will choke inflation off in the short term, which will allow it to lower rates over the coming months. The worst-case scenario, of course, will be if it raises the rates, inflation stays sticky and we are stuck in this death spiral of high debt costs for both corporates and for individuals, whether that be it's the personal financing or their rents and mortgages.

AO: And, you know, it's hard to say which way that will go at the moment. I wouldn't want to be sitting on the Monetary Policy Committee at this point. I mean, Dewi, there are some economists out there who argue that even at current rates, companies are already struggling. So do you think we might see a hike and then potentially some cuts after that to bring it down to a more reasonable level?

DJ: I think that's what the bank is hoping for. The question is, if inflation proves to be as sticky as it's been over the past few months, then they will have done all of this for naught. And then we've got the question of, are we looking at another 25, 50 basis points and what brings this to an end?

And the reality of it may be that what will bring it to an end and what will bring rates down, when we're in a situation where we've already got an inverted yield curve, which is a reasonable predictor of inflation, but it's not necessarily the bank hikes themselves that will bring things back into line. It's the effect of this pushing the economy into a recession.

Well, we have to leave it there. I'm sure we'll be checking in with Dewi after the BoE decision. That was Dewi John, Head of Research, European Ireland, from LSEG Lipper. Until then, do check IG.com for more trading mistakes and also trading theories and how to avoid those mistakes. And of course, for any other analysis, tune in to @Angeline Ong on Twitter.