Who's next?

The Bank of England, which wrong-footed markets by forgoing a rate rise in November,  today became the first major central bank to launch a tightening cycle, raising its target rate to 0.25 percent from the previous 0.1 percent. The move comes a day after the Federal Reserve gave clear indications that it expected to start raising rates soon, given the continuing recovery in the US economy. 

The Bank of England's move comes amid record daily COVID cases counts in the UK and extreme uncertainty over the possible impact of the omicron variant. Economic growth has recently slowed to a crawl in the UK, with GDP still about 0.5 percent below its pre-pandemic peak.  However, the Bank's focus is firmly on the buildup of inflationary pressures. CPI is already rising at a 5.1 percent rate, and the Bank expects it to reach 6 percent in the next few months. 

It is far from clear that the Bank's action will have any direct impact on inflation in the near term. Much of the current price pressure in the UK, as elsewhere, is related to supply chain issues. These may have been exacerbated by Brexit, but they are not something that can be addressed by raising rates. It seems likely that the Bank is looking to head off higher inflation expectations before they can take firm hold; memories of the double digit inflation rates of the 1970s may still lurk not far beneath the surface of public consciousness. 

No central bank starts a rate hike cycle thinking that one move will be all that is needed. However, the uncertainty over omicron means that today's move may indeed be "one and done", at least for the next several months.  This analysis from an article in The Guardian sounds right:

Hannah Audino, an economist at the accountancy firm PwC, said speculation the Bank would embark on further rate hikes in the spring could be wide of the mark.

“With [Covid-19] cases at record levels and expected to continue rising, the risk of further social distancing measures, and signs that business confidence is already weakening, it is likely this modest rate rise could be the first and only one for some time.”

Moving on to the US, we find that the Federal Reserve is continuing to clear the decks for a rate hike by accelerating the taper of its quantitative easing bond purchases. It is reducing its purchases by an aggregate of $30 billion per month ($20 billion for Treasuries and $10 billion for MBS), starting in January, with indications of similar-sized reductions after that. If this actually happens, new QE purchases would fall to zero before the end of Q1/2022. 

The Fed continues to stress that "it will be appropriate to maintain this target range until labor market conditions have reached levels consistent with the Committee's assessments of maximum employment."   However, the detailed economic and financial projections that accompany the FOMC statement reveal that its base case expectation is that it will raise rates by 75 basis points in 2022 and by a further 75 basis points in 2023. 

Some of the same caveats as in the UK apply equally in the US. It is not clear that the current inflationary pressures that have carried US headline CPI above 6 percent can be addressed by raising interest rates. That said, however, the growth outlook for the US, even in the face of omicron, looks considerably more robust than that for the UK. So expect the Fed to be the next to jump, probably by April, and for there to be more than one move in fairly short order.