Fed rate hike could light a rocket under the UK base rate

Should the Bank of England raise the base rate on 3rd August? No, but will they? Almost certainly, especially now that the US Federal Reserve have raised theirs whilst in a better economic position. The Bank of England will just keep beating the same drum and hoping for a different tune.

The Fed raising rates by 0.25% was expected because in this market central banks can’t afford to take any chances. This exerts pressure on the Bank of England to keep the “pedal to the metal” and drive down inflation in H2. Three successive hikes of 0.25% look likely to steer inflation to more acceptable levels. In the short term, rates will remain high but longer term rates should hopefully start to ease. 2024 is likely to be a better year for the property market.

As many had priced in this rise, the focus was more on what was said, which sadly proved to be not much at all. The Fed was laconic at best, simply saying it will go from meeting to meeting. Back across the pond, the Bank of England must focus on our own challenges, as UK inflation is sitting at well over double that of the US and four times the 2% target. With markets pricing a terminal rate of 5.8%, we should now expect more rises, certainly in August and likely beyond that.

This is a stark wake up call for anyone thinking that the MPC wouldn’t increase base rate further. The US are only 1% away from their inflation target yet still feel the need to increase rates. It’s now likely that we will see at least the same, if not a 0.5% increase. Hopefully this won’t upset swap rates and lead to more mortgage rate increases, as we’ve seen positive signs this week. If you’re on variable rate mortgage you may want to seek the shelter of a fixed rate mortgage for now, thanks to the storms that are blowing across from the Atlantic.

The Fed raised interest rates by 25bps to a 22 year high and the ECB are set to do the same. Both, however, are indicating this is likely to be the last. The Bank of England meet next on 3rd Aug so 0.25% hike is to be expected, followed by a summer of calm to regroup and take a view based on the next inflation data. Inflation pretty much rose month on month throughout 2021 and 2022, but in 2023, inflation has fallen every month, albeit slowly and from a dizzy height. If this trend continues, it won’t be long before Threadneedle Street views the trend as heading towards possible deflation and reduces interest rates accordingly.

This was a surprise from the Fed yesterday, and shows that even with much lower inflation there is still space for rate increases. This will definitely turn some heads at the Bank of England, in readiness for the next MPC meeting in early August, and again we all hang on how the Swap markets will react this morning. With a few days of small rate reductions, it's important to remember how quickly the mood can change, and potentially deliver a blow to mortgage borrowers.