Analysis: BoE rate hike push set to slow as Hunt tightens screw on economy

  • Government U-turn eases pressure on BoE to hike rates
  • Markets pull back bets on interest rate peak
  • Economists say BoE outlook complex, many moving parts
  • BoE must navigate tension between currency, government finances

LONDON, Oct 18 (Reuters) - The Bank of England looks set to slow its interest rate hikes after Britain's new finance minister ripped up a stimulus plan, raising the prospect of a deeper recession that will do some of the central bank's inflation fighting for it.

Jeremy Hunt on Monday stripped away most of Prime Minister Liz Truss's planned tax cuts and shortened her huge energy price cap plan to six months from two years, tightening the screws on the world's sixth-biggest economy in 2023.

Investors on Tuesday were pricing in a 66% chance the BoE will raise its benchmark Bank Rate by a full percentage point on Nov. 3, its next scheduled monetary policy announcement, down from a near-certainty before the sweeping fiscal U-turns.

Investors have also pared back their bets on the peak for Bank Rate which they now see at 5.25%, up from a current 2.25% but down from almost 6% predicted earlier this month.

On Tuesday, bank ING said it now expected the BoE to raise rates by 75 basis points next month, not 100 as it thought before, even as it said the shorter energy price cap could push inflation in 2023 to 7.6% from a previously estimated 5.9%.

But over the next two to three years - the BoE's time-frame for setting monetary policy - the reduction in subsidies to help households and businesses cope with soaring power bills is likely to cool inflation by weighing on spending and demand.

As well as the brake on the economy that will come from higher taxes and the shorter energy bill support programme, Hunt plans to cut government spending as he tries to repair the public finances and Britain's economic policy credibility.

"Clearly the downside risks to growth have increased," Sonali Punhani, an economist with Credit Suisse, said. "But the exact magnitude is difficult to know until we get more details."


Other central banks, such as the U.S. Federal Reserve, are showing little let-up in their rate hikes as inflation - driven by soaring energy and food costs that are largely the result of the Ukraine war - remains stubbornly high.

But the outlook for the British economy has changed so markedly that the picture looks different for the BoE.

"The BoE is in a bit of a unique situation with so many moving parts," Punhani said. "The fact that so much fiscal stimulus has been reversed and the energy support has been curtailed does reduce the pressure on them somewhat."

But the debate for the BoE is far from clear-cut.

If it relaxes the pace of its interest rate hikes by more than investors expect, it could further weaken the value of the pound, which has fallen by 16% against the dollar this year, aggravating inflation pressures.

But higher borrowing costs will add to a cost-of-living squeeze that will worsen for many households after April, when the energy support programme will be refocused towards the most vulnerable.

Businesses will also be exposed to higher energy bills just as they are due to be hit with a jump in corporation tax, part of Hunt's drive to restore Britain's fiscal reputation.

Last week, the BoE won some praise for protecting its own credibility as an independent central bank when it stuck to its Oct. 14 deadline for ending its emergency purchases of government bonds, launched to quell the market turmoil that followed Truss's Sept. 23 mini-Budget.

The refusal to extend the deadline was widely seen as contributing to the pressure on Truss, who fired her friend Kwasi Kwarteng as finance minister shortly before the BoE deadline and then agreed to the about-turn on her tax cut plans.

While interest rate hikes could give Hunt an extra headache by increasing the government's debt interest costs, analysts expect a smoother relationship between the central bank and the government after strains in recent months as allies of Truss accused the BoE of failing in its inflation fight.

"I expect the Bank of England will be responding only to the inflation picture," Punhani said. "I expect them to continue to do that."

Writing by William Schomberg; Editing by Catherine Evans

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