Bank of England official hints interest rates may not rise as much as market expects
Might interest rates not peak as high as the market is expecting?
That is certainly the conclusion that has been drawn today following a speech by Ben Broadbent, deputy governor for monetary policy of the Bank of England, in which he discussed the impact of the pandemic and Russia’s invasion of Ukraine.
Speaking at Imperial College London, Mr Broadbent – in language rarely used by a member of the Bank’s rate-setting Monetary Policy Committee (MPC) – more or less told financial market participants that they were pricing in too many future increases in Bank rate.
In his speech, Mr Broadbent discussed recent movements in the market’s expectations for how high Bank rate might go, pointing out that, as recently as the Monetary Policy Report in August, prices in financial markets were consistent with Bank Rate rising to a peak of 3% next spring and then falling back a little over the following year.
But he pointed out that, despite a decline in recent days, that expected peak was now around 5.25%. He said that this was “by some distance” the largest rise in market interest rates between MPC forecasts since the committee was founded in 1997.
Mr Broadbent said that, were that to come to pass, the cumulative impact of interest rate rises over the “entire hiking cycle” would be sufficient to reduce the UK’s GDP by just under 5%.
He added: “It would imply a pretty material hit to demand over the next couple of years.”
In his crucial concluding remarks, Mr Broadbent said: “Whether official interest rates have to rise by quite as much as currently priced in financial markets remains to be seen.”
His comments immediately had an interest on market expectations. Last night, the market was pricing in a peak for Bank Rate of 4.785% but that has slipped today to 4.68%. A week ago, prior to the new chancellor Jeremy Hunt tearing up most of his predecessor Kwasi Kwarteng’s mini-Budget, market expectations for peak Bank rate were at 5.099%.
Ben Broadbent, deputy governor for monetary policy of the Bank of England
Impact of the energy price guarantee
Central to the MPC’s deliberations, Mr Broadbent made clear, would be the government’s energy price guarantee aimed at protecting households and businesses from soaring energy bills this winter.
He noted that, for as long as it was in place, the guarantee would have the effect of limiting headline inflation and, with it, any related so-called ‘second-round’ effects – the term used to describe how a high level of inflation can feed into further inflation by, for example, prompting workers to demand inflation-busting pay increases.
But he pointed out that the guarantee would also reduce “the severity of the hit to household incomes” by soaring energy prices and, as a result, would support demand – something that would, in normal circumstances, add to inflation. He reminded his audience that the MPC had already judged that the second effect was likely to outweigh the first.
Mr Broadbent pointed out that on Monday, Mr Hunt had said the energy price guarantee would be maintained only for six months, rather than the two-year period originally planned.
He added: “He suggested support was likely to continue, beyond six months, albeit in a more targeted fashion. But we are unlikely to know for a while precisely the form that will take.”
Mr Broadbent said that, if government support for households and businesses on energy prices were to mitigate the impact of higher inflation, there would be “more at the margin for monetary policy to do”.
And he went on: “The MPC is likely to respond relatively promptly to news about fiscal policy.”
That was a clear hint that were Mr Hunt to continue with the energy price guarantee beyond March next year, having said on Monday this week that it would come to an end then, the MPC might have to respond by setting a higher level of Bank rate than might otherwise be the case.
Governor of the Bank of England, Andrew Bailey
A change in policy outlook
Mr Broadbent’s remarks today are all the more significant because they underline just how much the policy outlook for the UK has changed during the last week.
It was only as recently as last Saturday that Andrew Bailey, the Bank’s governor, delivered a speech at the International Banking Seminar in Washington in which he said: “We will not hesitate to raise interest rates to meet the inflation target. And, as things stand today, my best guess is that inflationary pressures will require a stronger response than we perhaps thought in August.”
Since then, in a bid to pacify the bond market, Jeremy Hunt has unwound most of Mr Kwarteng’s unfunded giveaways and set a date, 31 October, on which he is expected to come up with further tax increases and public spending cuts to plug the government’s fiscal hole.
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Gilt yields – implied government borrowing costs – have fallen sharply from where they were immediately after the mini-budget.
Mr Broadbent’s comments today suggest that, so too, should market expectations of where Bank rate will peak.
One of the UK’s largest water companies is considering shipping supplies from Norway to the UK.
Southern Water said the idea was a “last-resort contingency measure” in case of extreme droughts in the early 2030s.
Up to 45 million litres could be brought to the UK per day under the proposals.
The Financial Times, which first reported the potential move, said the water, from melting glaciers by fjords in the Scandinavian country, would be transported by tankers.
It comes as fears grow over the future of water services in the UK following droughts in the summer of 2022 when some areas of the country came close to running out of supplies.
The Financial Times said Southern Water was in “early-stage” talks with Extreme Drought Resilience Service, a private UK company that supplies water by sea tanker.
The firm would pay for the measure out of customers’ bills, according to the report.
Southern Water, which covers Hampshire, Kent, East and West Sussex, and the Isle of Wight, currently gets its supplies from groundwater and rare chalk streams.
However, the Environment Agency (EA) has urged the firm to reduce its reliance on such sources amid concerns over the environmental impact and fears they could make the risk of droughts worse.
‘Costly and carbon-intensive’
Water firms have come under growing criticism in recent years over sewage spills and rising bills, with households facing an average increase of 21% over the next five years.
Companies have also been urged to improve their infrastructure to help supplies. Currently around a fifth of water running through pipes is lost to leaks, according to regulator Ofwat.
And a report by the EA earlier this year found that Southern Water, along with Anglian Water, Thames Water and Yorkshire Water, was responsible for more than 90% of serious pollution incidents.
Following criticism over sewage discharges, Southern Water’s chief executive Lawrence Gosden blamed “too much rain” in 2023 for the problem during an interview with ITV News.
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The company said it was facing a shortfall of 166 million litres per day in Hampshire alone during future droughts.
But the firm said it was already undertaking other measures to address the problem, including by building the UK’s first new reservoir in more than three decades in Havant Thicket.
However, Greenpeace UK’s chief scientist Dr Doug Parr criticised the Norway proposal and said the firm should focus more on addressing issues domestically.
“Tankering in huge quantities of water from Norway will inevitably be a costly and carbon-intensive alternative to that of doing a better job with the water resources that are available in a rainy country like the UK,” he said.
He added: “Despite the obvious failings of planning, water companies need to start thinking of potable fresh water as a precious and finite resource, and plan to start treating it as such.”
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From 2022: How can we protect ourselves from water crisis?
Tim McMahon, Southern Water’s managing director for water, said: “We put less water into supply now than we did 30 years ago and measures like reducing leakage have enabled us to keep pace so far with population growth and climate change.
“As we work to take less water from our chalk streams and build new reservoirs like Havant Thicket in Hampshire, we need a range of options to help protect the environment while this infrastructure comes online.”
Mr McMahon added: “Importing water would be a last resort contingency measure that would only be used for a short period in the event of an extreme drought emergency in the early 2030s – something considerably worse than the drought of 1976.
“We’re committed to continuing to work with our regulators on developing the right solutions to meet the challenge of water scarcity, while protecting the environment.”
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