How will markets react to the next Bank of England rate decision?

Over the past 18 months, the Bank of England (BoE) has hiked interest rates from 0.1% to 5.25%, but after driving one of the most aggressive rate cycles in history, the central bank hit pause at its last meeting. 

The Monetary Policy Committee (MPC), responsible for setting interest rates, held the key rate at 5.25% when it last met in September. The next rate-setting meeting is Thursday, 2 November 2023. 

The Bank of England’s balancing act  

The MPC faces a tough choice when it next meets. 

Subscribe to MoneyWeek

Subscribe to MoneyWeek today and get your first six magazine issues absolutely FREE

Get 6 issues free

Sign up to Money Morning

Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter

Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter

Sign up

One of the main aims of the central bank is to keep inflation at or around 2%, which it does by increasing or reducing interest rates. Inflation has slowed this year, falling from a high of 10.7% printed toward the end of 2022 thanks, in part, to the BoE’s aggressive hiking cycle. 

However, the most recent data showed inflation held steady at 6.7% in September thanks to rising petrol prices, bucking forecasts for a further slowdown.

This trend could further complicate the BoE’s decision. The UK and other global economies are facing the threat of conflict across the Middle East, which could spike oil and gas prices, cause another supply-driven inflation shock, and impact confidence, hitting the country’s fragile economy.

GDP grew just 0.2% in August, following a 0.6% quarter-on-quarter fall in July, and consumer, as well as business confidence, has continued to fall, suggesting the economy is only getting weaker. Meanwhile, the UK's wage growth is notably higher than in the US and the eurozone, suggesting inflation could remain sticky.

The “Table Mountain” approach  

While it’s unclear at this stage which direction the BoE will take, its chief economist, Huw Pill, has referred to their preferred approach as the "Table Mountain" strategy, named after the flat-topped landmark in South Africa, which reflects their plan to sustain high-interest rates until the inflation threat subsides.

This strategy aims to prepare the UK public for a prolonged period of high borrowing costs to significantly suppress inflation rather than destabilising the economy with sharp rate hikes followed by steep cuts.

The BoE’s decision will likely have a different impact on different assets. Here’s how markets could react to the central bank’s next rate decision. 

How assets could react to the next interest rate decision  

Sterling

Sterling dipped to an all-time low against the US dollar last year amid the turbulence of the short-lived Lizz Truss government. 

While the pound has recovered over the past year, it remains under pressure due to the UK's fragile economic position and the growing divergence between the UK economy and the US economy. 

If the BoE decides to hold or cut interest rates, it could signal further weakness ahead for the pound against the dollar and other currencies. 

However, if the central bank abandons its dovish stance, and decides to hike rates further after September’s decision to hold, it could be good news for the pound. 

Real estate stocks

Real estate stocks, such as housebuilders and real estate investment trusts (REITs) could see some buying if the MPC holds interest rates at their current level. 

Higher rates are already having a noticeable impact on the UK’s property market, with house prices weakening and construction activity falling. 

If the BoE decides to hold rates at 5.25% at the next announcement, it could be a net positive for the sector as it’ll remove uncertainty around future financing costs and promote stability in the mortgage market. 

On the other hand, a hawkish hike or hawkish commentary from the MPC could lead to higher costs for mortgage borrowers and depress overall sentiment in the sector. 

Bank stocks 

UK bank equities could see a bid off the back of another BoE hike as they’ll be able to increase the rate of interest they charge to borrowers when taking out loans. They’ll also be able to earn a higher rate of return on their reserves, which are mainly held at the BoE and invested in short-term government securities. 

That being said, if higher rates start to have a detrimental impact on the UK economy, banks will suffer as the demand for loans will fall and lenders may have to increase loan loss provisions as borrowers fall behind on repayments. 

UK gilts 

UK gilt prices move inversely to interest rates, and as the BoE has hiked rates, gilt prices have slumped with some longer-dated issues losing as much as 70% of their face value (longer-dated gilts, such as 50-year issues, are far more sensitive to higher rates. While the price can vary during the life of the issue they’re redeemed at par at the end of their life.)

If the MPC decides to push interest rates higher, UK bonds are likely to continue to sell off. The cost of government debt will also rise, good news for savers but bad news for the government’s financial position. 

At the same time, investors will be looking for further commentary around the BoE’s bond sales programme, or quantitative tightening. 

In September the MPC unanimously agreed to raise the pace of its quantitative tightening process for the year ahead from £80bn in 2022-23 to £100bn in 2023-24 - putting further selling pressure on bonds. A slowdown in sales will be favourable for bond prices. 

To prepare yourself for what could be a big week for the BoE and UK assets, visit IG to use their powerful trading tools to get ahead of the market, plan and execute your trades.