Are UK interest rate rises coming to an end?

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The latest 0.5% increase to UK interest rates takes them to 4%. But where will they need to reach to successfully rein in inflation? And will it dampen recent market enthusiasm? Read our latest outlook for the UK economy and markets. 

The latest 0.5% increase to UK interest rates, taking them to 4%, was widely expected by financial markets. But, once again, the Bank of England’s (BoE) decision makers – the nine members of the Monetary Policy Committee (MPC) – were not all in agreement about the move, with two members voting for no change at all. A sign that mixed economic data is making for difficult decisions.

The big question for economists and investors is whether this tenth consecutive rate rise is close to being the last. We asked our colleagues at Phoenix Asset Management for their views on the outlook for inflation, interest rates and markets.

Standard Life is part of Phoenix Group, the UK’s largest long-term savings and retirement business. We work closely with our colleagues at Phoenix Asset Management to determine the outlook for markets and the investment strategy for our pension solutions. They have provided the following views.

Are UK interest rate increases working to curb inflation?

Yes, and no. The good news is that consumer price index (CPI) inflation has come down thanks to lower oil and gas prices. Having peaked at 11.1% in October, it’s at 10.5% at the time of writing. 

Certainly, we’ve seen consumers feeling drained. December’s unexpected fall in retail sales topped the worst year on record. The volume of goods bought in shops and online marked the sharpest fall since records began in 1989. Consumer confidence also slid for the first time in four months towards record lows. 

Most concerning for the BoE, is that both core inflation, which doesn’t include food and energy prices, and services inflation remains high, while wage growth continues to outpace the Bank’s and market expectations. In addition, the economic outlook has improved, with the recession likely to be shallower than previously forecast.
 
What does this mixed bag of data mean overall? It’s clear that households are suffering from the cost of living crisis, as wages have failed to keep up with inflation. However, the BoE must be mindful of higher wage settlements creating future inflation pressures down the track.

Does this mean we could expect further interest rate rises?

Yes, at Phoenix Asset Management, we expect the MPC to slow the next increase to 0.25% at the next two meetings (which take place in March and May) before pausing with rates at 4.5%.

The bank has softened its outlook guidance, preparing the way for a reduction in the pace of future interest rate rises. They’ve dropped the word ‘forceful’ in their description of further tightening and are now saying that: “If there were to be evidence of more persistent pressures, then further tightening in monetary policy would be required.".

UK markets have had a strong start to 2023; will the outlook for interest rates change that?

The investing narrative is about inflation falling globally, economic activity proving more resilient than expected, and the monetary policy tightening cycle (increasing interest rates) nearing its peak. 

We’re in what markets call a ‘goldilocks scenario’ – when economic growth is enough to prevent a recession but not enough to increase inflation by too much. These conditions have supported equity and bond prices since the beginning of the year and could continue for some time. 

However, the big question remains: can inflationary pressures fall sufficiently to allow central banks to ease policy? All eyes are focused on how much central banks can cut interest rates in the second half of the year, underpinning future economic growth. 

The improved economic backdrop could keep demand for labour high, fuelling further wage rises – meaning interest rates may have to be kept high for much longer than markets expect. This is likely to be hotly debated for much of the year and supports the need for diversified portfolios. 

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The information here is based on our understanding in early February 2022 and shouldn’t be regarded as financial advice. The value of pension plans and other investments can go down as well as up and may be worth less than what was paid in.