If interest rates stay higher for longer, getting rates wrong will lead to more pain for borrowers.
Policy makers have been burned by markets before – just ask Liz Truss or Kwasi Kwarteng. The former prime minister and chancellor were forced to reverse large parts of their £45bn package of unfunded tax cuts after it led to a rise in borrowing costs that eventually forced them out. It’s been a crazy shopping spree this past month. And one that officials tried to erase from the forecast. At one point during the post-mini-Budget market chaos, investors predicted the Bank of England would have to raise interest rates to 6%, a disaster for mortgage holders. The government moved its autumn statement to November, in part to avoid the worst of that jump in borrowing costs that would be reflected by the Office for Budget Responsibility, the government’s official forecaster. The Bank also reduced the usual 15 working day window to meet market rates to just seven working days until October 25 to avoid a big rise in borrowing costs. Markets currently expect rates to peak just below 5%, but Bailey and his fellow regulators have been unusually quick to throw cold water on even those subdued expectations. So, how high would interest rates have to go to check price increases? Economists at ING believe rates will rise to less than 4%, noting that a “widely divided” MPC is unlikely to push borrowing costs much higher. James Smith, economist at ING, said: “Central banks around the world need to assess whether continued aggressive rate hikes can be justified at a time when housing and corporate lending markets are beginning to crack. “The choice facing the Bank in the coming meetings is an aggressive hike to protect sterling or a more cautious move to allow mortgage rates to gradually fall. With around a third of UK mortgages set for just two years on, we suspect the latter option will increasingly be seen as more palatable.” Smith expects a further increase of 0.5 points in December and does not believe the Bank will go above 4% in 2023. However, markets and some forecasters believe Bailey will need to back off. The Governor could put his reputation on the line if he has to go much higher than he has signaled, as other central banks, such as the US Federal Reserve, promise more aggressive action to tackle inflation.