Bank of England seen raising interest rates to 13-year high

The Bank of england this week is expected to raise interest rates to their highest level in 13 years and clarify how it plans sell off some of its 847 billion pounds ($1.1 trillion) in government bond holdings.

The move would take the UK central bank into unchartered territory, since none of its majoreconomy peers have yet sold government bonds accumulated under quantitative easing since 2008.

Policy makers led by Governor Andrew Bailey have to balance efforts to contain inflation that has leaped to a 30-year high against the risk that raising rates will slow the recovery.

“The BOE is in an awkward position as the war in Ukraine has exacerbated the already toxic mix of slowing growth and high inflation,” said Silvia Dall’angelo, senior economist at Federated Hermes Ltd.

Markets, investors and economists expect the nine-member monetary policy committee to vote on Thursday for a quarter point hike in the benchmark lending rate to 1 percent. That would be

the fourth increase in a row and match the level in February 2009, when the BOE was aggressively cutting borrowing costs in the financial crisis.

A quarter point rise would mean rates reach the threshold at which policy makers have said they will consider starting active sales of the gilt portfolio, which peaked at 875 billion pounds at the end of last year.

The process of “quantitative tightening” began in March, when 28 billion pounds of gilts matured and rolled off the balance sheet. Investors have expressed concern that active sales will unnerve markets without a published and detail detailed plan.

To provide clarity, the BOE is expected to launch a consultation or review into active sales alongside Thursday’s rate decision.

“I suspect they won’t be rushing to reduce QE,” Martin Weale, a former BOE rate-setter who backed QE during his six years from 2010 on the committee, told Bloomberg. “A consultation is an obvious way of delaying it.”

The BOE could open a consultation on selling gilts in May for 12 weeks or so and could report in August about exactly how and when it might sell assets, said Elizabeth Martins, UK economist at HSBC Holdings Plc.

Bailey has stressed the BOE will move carefully and not sell in times of fragility in financial markets.

“When it does conclude its review, liquidity and financial conditions permitting, we think active sales will start at a pace of around 4-5 billion pounds a month,” Martins wrote in a note to clients.

Alongside the decision on rates, the BOE will unveil its latest forecasts for inflation and growth. Those are expected to show inflation creeping close to double digits toward the end of the year and economic growth slowing to a crawl.

Rocketing energy and food costs have precipitated the worst cost of living crisis since the 1950s, with the war in Ukraine threatening to worsen the price shock.

Sterling has collapsed from $1.30 to $1.25 in the past week after the International Monetary Fund said the UK faces stickier and higher inflation than any other leading industrialized economy.

Bloomberg Economics estimates that inflation could hit 9 percent in April and GDP could contract in the three months to June.

Weale, professor of economics at Kings College London, said the UK is now facing “stagflation,” the toxic combination of weak growth and high inflation, and that he would raise rates by a quarter point. “At least in the 1970s underlying growth was stronger than it is now,” he said.

Charles Goodhart, another former BOE ratesettter, would also raise rates by a quarter point at this meeting. “To stop raising rates at a time when inflation is worsening would be a bad signal in terms of inflation expectations,” he said.

Bailey has stressed the difficult trade-off, saying in April that policymakers face the “most severe test since independence 25 years ago” as they walk “a very tight line between tackling inflation and the output effects of the real income shock, and the risk that could create a recession.”

In March, eight MPC members voted for a quarter point hike. One member, deputy governor Jon Cunliffe, voted to hold rates at 0.75 percent. Investors are betting rates will rise above 2 percent before the end of this year.