Interest rates must rise sooner to combat rising threat of inflation, banks warn
Bank of America Merrill Lynch and Credit Suisse have urged the Bank of England (BoE) to raise interest rates faster than expected to avoid soaring inflation rates.
The call comes as the two banks brought forward their projections for the first interest rate rise since August 2018. While the lenders were previously forecasting no rate rises until 2023, they have said that they expect a 15 basis point rate increase to 0.25% next May.
Credit Suisse said that the economy was recovering faster than the BoE predicted in its monetary policy report last month. The bank said it thought the conditions for tightening policy could be met sooner.
It said: “The recovery in the UK is proceeding faster than expected. We have upgraded our UK GDP growth forecasts from 6.5 per cent to 7.5% and expect the economy to return to pre-Covid levels by Q4, 2021.
“Our view is that the strong growth recovery and drop in UK labour market supply due to Brexit can lead to a large-scale reabsorption of furloughed jobs into employment in the next few months and slack being eroded quicker than the Bank of England forecasts.”
While most economists do not expect any rate rises until 2023, the markets are preparing for an increase in 2022, even more so now that the US Federal Reserve has brought forward its forecasts for the first interest rate increase to 2023, The Times reports.
Projections published in the BoE’s May report indicated that rates may have to increase from 0.1% to 0.35% before the end of 2022.
On Friday, Bank of America and Credit Suisse predicted that rates would end 2022 at 0.25%. Bank of America forecast there would be no further rises in 2023 as policymakers would then start to tighten quantitative easing measures. Simultaneously, Credit Suisse is anticipating another two rate rises in 2023, taking the BoE’s base rate to 0.75% by the end of that year. This was the level rates were at before the pandemic hit.
The BoE is not expected to increase rates when it meets this week, however, minutes from the meeting may indicate whether policymakers are preparing for a faster-than-expected recovery.
Economic data published last week revealed that inflation is above the BoE’s 2% target at 2.1% and while wages in the UK are rising steadily.
On Friday, ratings agency Fitch also revised its outlook for the UK economy to “stable” from “negative”. The firm said public finances had proved more resilient to the impact of the pandemic than expected and that the unemployment rate would be 5.4% this year compared with its previous forecast of 7.3%.
While inflationary pressure is increasing, households’ expectations of inflation over the coming year have dropped. In its quarterly Inflation Attitudes Survey, also published on Friday, the BoE asked respondents about the existing rate of inflation and received a median response of 2.5%, unchanged from February.
Expectations for the coming year fell from 2.7% to 2.4%, suggesting households are more optimistic about the risk of the economy overheating.