5.5 percent could be the ‘peak’ rate

Bank of Ireland’s Chief Economist, Dr. Dan McLaughlin has said he expects the Bank of England to announce a quarter point increase in official sterling rates, taking the Bank rate there to 5.5%. He also expects that the ECB is likely to leave rates unchanged at the moment and will signal a move in June.

“The Bank of England’s decision looks clear-cut, although it has to be said that the MPC has surprised of late and appears to be split on fundamental grounds.

Some members are concerned that the UK economy has limited space capacity, that firms have stronger pricing power, and that monetary growth is extremely buoyant, which also adds to their perception that there are upside risks to inflation. This approach led two members of the MPC to vote for a rate rise in April, and no doubt they have not changed their minds since.

Another minority view, articulated in recent months, is that there is considerable space capacity in the labour market and that wage pressures have been benign, so the risks to inflation are on the downside. The majority view, which has prevailed in keeping rates unchanged at 5.25% since January, highlights a number of uncertainties about the outlook for UK growth and inflation, but acknowledges that the Bank’s February forecast projected inflation to be above the 2% target in two years’ time on unchanged rates.

This suggests that rates will indeed rise again, in the absence of a major change in the economic outlook, and the shock acceleration in March inflation, to 3.1%, makes a move in May all the more likely,” said Dr Dan McLaughlin.

The April Bulletin maintains that the market expects such a move but has gone further by pricing in an additional rate rise later in the year, taking the repo rate to 5.75%.

Commenting on market expectations, he concluded that the market may have come to the wrong conclusion: “The risks are certainly on the upside, but in our view there are a number of factors arguing against such a move. Employment growth in the UK is slowing, underlying wage inflation is modest, and real household incomes are being squeezed.

As a result, economic activity may remain solid rather than effervescent. Indeed, economic growth in the first quarter appears to have been weaker than forecast by the Bank of England, so we retain our view that 5.5% may turn out to be the peak of the UK rate cycle. If this view becomes more widespread sterling would suffer, and we expect the UK currency to drift back below the $2 mark over the next few months.”