What Clues Did The Bank Of England Give Us About The Future Of Interest Rates

​Summary

• ​Interest rates are at a 15-year high
• The ​BOE kept rates unchanged as they wait to see inflation subside faster
• Still significant inflation pressures in the economy
• ​Interest rates are still expected to increase

​Interest Rates Highest in 15 Years

​On the back of a rapid rise in prices since the start of the Russo-Ukraine war, the Bank of England (BOE) has had to raise its key policy rate 15 consecutive times, bringing the rate from almost 0% in early 2020 to 5.25% today.  The inflation rate rose from just under 2% to over 11%, which is significantly higher than the Bank's target of 2%.

Bank of England Policy Rate

Source: Bank of England

​

Price pressures came from quite a few areas that are a key part of the basket of goods that the average household consumes on a daily basis. The main items are food and energy:

• ​A significant reduction in the supply of gas and oil to markets in Europe led to a rapid increase in the price of fuel at the pumps, utility bills, and second-round effects on the cost of groceries at the shops. 
• ​Poor harvests in certain countries further magnified the food shortage.
• ​Follow-on impact of the pandemic, which saw a shortage of certain goods and services while demand remained high.
• ​ A significant increase in wages and salaries, as companies tried to incentivise staff to return to the office. Businesses also had to adjust salaries to account for the general increase in the cost of living.

Where Will Rates Go In the Months ​Ahead

All indications point to the possibility of rates increasing further. At its most recent monetary policy meeting on 21 September 2023, the Bank decided in a split vote (5-4) to keep rates unchanged. It is important to note that four of the 9 committee members voted for a 0.25% increase which would have put the rate at 5.5%. In the bank's press release they hinted at the possibility of rates increasing further, they mentioned that: 

The Committee had continued to judge that the risks around the ... inflation forecast were skewed to the upside, albeit by less than in May, reflecting the possibility that the second-round effects of external cost shocks on inflation in wages and domestic prices take longer to unwind than they did to emerge. Since the MPC’s previous meeting, global growth has evolved broadly in line with the August Report projections..... Spot oil prices have risen significantly, while underlying inflationary pressures have remained elevated across advanced economies.

— Bank of England

​Judging by the statements it seems the BOE is taking a wait-and-see approach because of the recent slowdown in inflation, but is leaning towards more increases as there are early signs of a significant increase in oil prices. 

​There are more clues in the previous - August 2023 - monetary policy report so let's take a look. In the previous report, the Bank did mention that they expect inflation to decline substantially as we approach the end of the year (about 5% by year-end). Inflation has fallen to 6.7% recently so they are on track to meet this target with 3 months remaining in the year, so not unexpected. In the same report, the bank highlighted a few important forecasts:

• Inflation to keep falling in 2024 and meet its 2% target by early 2025.
• Interest rates to continue increasing until Q3 of 2024.​

Bank of England Inflation Forecasts

Source: Bank of England

​

The Bank has also provided some estimates of future policy rates which signal some consensus about where rates are heading

​As you can see from the information provided, interest rates could potentially hit a high of 6.0% in 2024, before climbing down to  4.5% by 2026. Inflation on the other hand is expected to drop substantially to below the Bank's target by 2025.

​Implications

​With interest rates staying higher for longer, there are a couple of things that should be high on the agenda:

• ​Debt reduction. Keeping debt levels low will protect against further unexpected rises in interest rates. You will also save on interest expenses.
• ​Keep an eye on cost, while focusing on high-return projects. The hurdle rate for projects is now significantly higher. You should pursue a project that can provide rates of return in excess of 5%, otherwise, you would be better off placing your funds in a fixed deposit.
• ​If debt pre-payment comes at a cost, you should build up some extra cash and place it in an interest-bearing account to offset your interest cost.
• ​Seek out revenue diversification. The economy will likely slow, and so better revenue diversification can give you downside protection.