Home Crypto Analysis Explainers Projected UK Interest Rates in 5 Years: Will Persistent Inflation Force BoE’s Hand?

Projected UK Interest Rates in 5 Years: Will Persistent Inflation Force BoE’s Hand?

Giuseppe Ciccomascolo
Last Updated September 21, 2023 1:22 PM
Key Takeaways
  • Bank of England paused rate hikes after 14 consecutive increases.
  • Rates play a fundamental role in tackling high inflation.
  • A new decision is set to be announced on November 2.
  • How do interest rates influence cryptocurrencies?

On Thursday, September 21, 2023, the Bank of England made a surprising decision to refrain from raising UK interest rates, opting for a pause after a milder-than-anticipated inflation report on Wednesday provided some relief to Threadneedle Street.

The Bank of England maintained the bank rate at 5.25%, a level not seen in over 15 years, which diverged from the expected 25 basis point hike according to FXStreet’s consensus. The recent, more subdued UK inflation figures led some investors to scale back their rate hike expectations.

This decision breaks a streak of 14 consecutive rate hikes that began in December 2021, raising the bank rate from its pandemic-induced low of 0.10%. It marks the Bank of England’s first pause since November 2021.

Economic Data Slightly Improved

The Bank of England’s statement regarding its decision reads as follows: “Five members of the committee believed that maintaining the bank rate at 5.25% was the appropriate course of action at this meeting.”

They pointed to signs of loosening in the labor market and highlighted the recent notable increase in average weekly earnings, though this increase was not reflected in other wage measures. While it was cautioned not to rely too heavily on a single data point, it was observed that headline and services CPI inflation had retreated and were lower than anticipated.

On the other hand, one committee member expressed concern about the growing risks of policy overtightening, which could lead to output losses and increased volatility, necessitating more abrupt policy reversals. The lag effects of monetary policy meant that substantial impacts from previous rate hikes were still forthcoming.

UK inflation rate over the years
UK inflation reached its peak after post-pandemic period

Those in favor of a rate hike cited evidence of more persistent inflationary pressures.

The recent release of the UK consumer price index data significantly influenced the meeting. In August, consumer prices rose by 6.7% annually, a slight easing from the 6.8% increase in July. This reading fell short of market expectations, as forecasted by FXStreet, which had predicted an inflation rate of 7.1%.

The annual core inflation rate, excluding energy, food, alcohol, and tobacco, cooled to 6.2% in August, down from July’s 6.9%. The August reading was anticipated to be 6.8%.

In its efforts to combat rampant inflation, the Bank of England has raised rates by a total of 515 basis points during this current cycle of rate hikes.

Introducing the Bank of England (BoE)

The Bank of England (BoE) is the central bank of the United Kingdom, with a history dating back to 1694. It is the second-oldest central bank globally, following Sweden’s Sveriges Riksbank.

Initially founded as a private bank to serve the government’s financial needs, the BoE received a royal charter from King William and Queen Mary in 1694. At that time, its primary mission was to raise £1.2 million in loans to finance the war against France. Surprisingly, over 1,200 individuals from diverse backgrounds, including carpenters, grocers, merchants, doctors, knights, and even royalty, bought the bank’s shares, making them its inaugural shareholders. Notably, King William and Queen Mary themselves held shares in the bank.

As a central bank, the BoE’s primary objective is to maintain price stability by targeting an inflation rate of 2%. To achieve this, the BoE adjusts its key interest rate, known as the bank rate, as a tool to manage inflation.

The responsibility for setting the bank rate lies with the Monetary Policy Committee (MPC), comprising nine members, including the governor, the three deputy governors responsible for monetary policy, financial stability, and markets, and banking. Additionally, there is a chief economist and four external members, appointed directly by the Chancellor of the Exchequer, the second most significant cabinet member after the Prime Minister. MPC members serve fixed terms and can be replaced or reappointed. The committee convenes eight times a year, approximately once every six weeks, to decide on monetary policy actions.

Beyond its role in monetary policy, the BoE is responsible for producing banknotes, overseeing payment services, and regulating major banks and financial institutions, such as credit unions and insurers. Furthermore, the BoE manages the UK’s gold reserves and holds gold on behalf of other banks, boasting an impressive vault containing approximately 400,000 gold bars.

A Historical Glimpse at UK Interest Rates

A review of the Bank of England’s interest rate history  reveals a significant shift in approach beginning in February 2008. This shift was prompted by the global financial crisis, which originated in the United States with the housing market bubble in 2007 and subsequently impacted the UK economy.

Throughout 2008, the BoE implemented five rate cuts, reducing the rate from 5.25% in February to 2% in December. This 2% rate marked the lowest level since the banking crises of the 1880s and 1890s, as reported by the International Monetary Fund (IMF). It was also the lowest level since the Great Depression and World War II in the BoE’s interest rate history.

UK interest rates over the years
UK interest rates increased notably after the pandemic end

In March 2020, the BoE made two rapid interest rate cuts on the 11th and 19th of March, driving UK interest rates to an unprecedented low of 0.1%. This sharp reduction mirrored the emergency measures adopted by other central banks and governments worldwide to bolster their economies during the COVID-19 pandemic.

The Post-Pandemic Interest Rate Adjustment

The near-zero interest rate remained in effect until December 2021 , as the UK and other nations gradually reopened their economies. As the recovery gathered steam and inflation surged in tandem, the BoE increased the bank rate from 0.1% to 0.25% on December 16, 2021, marking the UK as the world’s first leading economy to raise its interest rates following the pandemic.

With the economy rebounding and commodity and energy prices soaring due to Russia’s invasion of Ukraine in February 2022, the BoE implemented eight rate hikes throughout 2022. By year-end, the bank rate had reached 3.5%. In 2023, the UK central bank continued its tightening policy, raising rates by 50 basis points (bps) to 4% in February, followed by a 0.25% increase to 4.25% in March and an additional 25 bps in May, pushing the rate to 4.5%.

Post-Pandemic Pound Performance

The prospect of a more aggressive approach to interest rates by the Bank of England appears to be the primary reason for a rally that the pound began in April of this year. The markets are particularly attracted to the substantial coupon flows from British Gilts.

UK sterling performance
UK pound didn’t collapse as feared after pandemic and Brexit

UK ten-year yields are among the highest in G10 countries, even competitive with Italian BTPs. The interest rate differential (30 basis points on Italian BTPs) is thus driving the British currency to its 2023 highs. Wage growth is a concern for the Bank of England, which, according to the market, is expected to raise interest rates with three or four hikes by the end of the year, reaching 5.75%. Wages have grown by 5.8% (year-on-year) in the first quarter of 2023, and this could push the plateau to 5.4% by the end of 2023. The labor market shows no signs of slowing down, with unemployment still low at 3.8%.

Assessing the Peak of UK Inflation in 2022

Inflation is expected to play a pivotal role in shaping the UK’s key interest rate in the short to medium term.

In 2022, UK inflation accelerated, with the consumer price index (CPI) reaching a peak of 11.1% in October. Although it temporarily receded towards the end of the year, a surprise uptick to 10.4% in February was driven by rising food and non-alcoholic drink costs. Subsequently, inflation eased to 10.1% in March.

This dynamic backdrop of inflation, along with economic growth and labor market conditions, will likely continue to influence the Bank of England’s interest rate decisions in the coming years.

UK Interest Rate Projections for the Next 5 Years

The Bank of England hasn’t provided new insights into the UK interest rate forecast for the upcoming five years, extending its forecasts up to 2026 in its September report.

According to the BoE’s projections, interest rates are anticipated to reach 4.4% (slightly below the current rate) in the second quarter of 2023. These rates are expected to persist through Q2 2024, before gradually decreasing to 3.8% in Q2 2025. By 2026, the bank envisions the rate stabilizing at 3.6%.

In contrast, ING’s long-term interest rate forecast, as of May 12, suggests that policy rates will remain at 4.5% throughout 2023. However, it foresees a shift in the second quarter of 2024, with rates being trimmed to 4%, followed by further reductions to 3.5% and eventually 3% in subsequent quarters. ING predicts that by 2025, UK interest rates will settle at 2.5%.

This outlook aligns with Scotiabank’s forecast as of April 28, which indicates interest rates at 4.25% for 2023, followed by a decline to 3.25% in 2024.

The Impact of Interest Rates on Cryptocurrency

Cryptocurrencies, including Bitcoin, have exhibited remarkable resilience even in the face of rising interest rates. Notably, Bitcoin saw impressive growth, surging by 2,000% during the years 2015 and 2016, a period marked by increasing interest rates.

However, it’s essential to consider that elevated interest rates can have various effects on the cryptocurrency market. Some experts argue that persistent high inflation, escalating gas prices, and surging energy costs associated with higher interest rates may potentially reduce risk appetite, creating challenges for cryptocurrencies.

Central Banks and Their Influence on Cryptocurrencies

Central banks play a pivotal role in shaping economic conditions by directly impacting money circulation and financial market stability. Their ability to adjust interest rates directly affects borrowing rates for financial and banking institutions. In response to widespread inflation, central banks in major developed economies like the Federal Reserve (Fed), the European Central Bank (ECB), and the Bank of England (BoE) have chosen to raise interest rates.

The increasingly intertwined relationship between cryptocurrencies and these macroeconomic and monetary shifts is worth noting. The decisions to increase interest rates, particularly by the Fed, have immediate consequences for the cryptocurrency markets.

In simpler terms, the more assertive stance taken by the Fed has cast uncertainty over cryptocurrencies, influencing market sentiment as tighter monetary policies come into play.

As illustrated in the first chart below, most central banks have opted to raise interest rates, with only a few exceptions. Simultaneously, the second chart depicts the decline in Bitcoin’s value over the past year, indicating the interplay between central bank actions and cryptocurrency market dynamics.