Bank to hike at least 100bp in Nov.In order to shore up GBPUK economy already in recession

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The Bank of England will deliver a sizeable interest rate in November as it reacts to the government's new fiscal package and seeks to contain inflation, according to a major investment bank.

But it will also have one eye on the value of the British Pound, says a new report from Credit Suisse.

"We expect the Bank of England to hike rates aggressively from 2.25% to 4.5% by early 2023, with a hawkish pivot in November," says Sonali Punhani, Credit Suisse.

"A failure to respond aggressively to the fiscal package in November is likely to worsen the confidence problem that the UK is facing and risks further sterling weakness, higher inflation, higher risk premiums, and higher terminal rates," she adds.

The British Pound fell to a record low against then Dollar already this week amidst a negative market reaction to the announcement of unfunded tax cuts.

Investors are concerned for the trajectory of the UK's public finances and sold bonds as result, in turn raising the yield they pay, pushing up mortgage rates and the cost of other forms of corporate and personal finance.

"The BoE has not yet responded to this fiscal package by hiking aggressively. The UK's large fiscal deficit, along with the large current account deficit (8% of GDP), needs to be funded by capital inflows," says Punhani.

"Given the decline in credibility of UK institutions, markets are now demanding a high premium to finance these flows, which has led to a much weaker pound and higher UK yields," she adds.

The Bank of England has long been accused of being too complacent on the matter of domestic inflation, underwhelming against market expectations for the scale of hikes required.

This has in turn fed into a weaker Pound.

But Punhani says the UK is facing a broader confidence problem, "some elements of which can be compared to emerging markets".

Two things must happen for confidence in the Pound to be restored, says the analyst:

1) A credible fiscal plan that can stabilise the public finances, which is possible via spending cuts. This could come at the occasion of the fiscal review due in November

"We are not confident whether this would happen," says Punhani.

2) The Bank of England would need to restore credibility in the system by hiking aggressively in the near term.

Credit Suisse say this is their base-case scenario and they expect a hawkish pivot in November with at-least a 100bp hike, followed by at least 75bps in December and a commitment to continue hiking to get inflation under control.

The hikes will be justified by forecasts showing inflation is to stay above the Bank of England's target in 2023 and fall back to 4.0% by the end of 2023.

"The labour market remains tight with unemployment at multi-decade lows and wage growth having been stronger than expected at 5.2% currently. While there are signs of a slight moderation in labour demand, it is still at extremely robust levels," says Punhani.

Economists at Credit Suisse meanwhile believe the UK economy entered a recession in the second quarter.

Second quarter GDP was negative owing to the extra bank holiday in June and an extra bank holiday in September and weakness in consumer spending implies that it is likely that the third quarter GDP reading is also negative.

This would fulfil the definition of a technical recession.

The recession will be a long one, lasting through the winter and into the middle of 2023.

Credit Suisse expects a peak-to-trough GDP decline of 0.7% and that GDP slows to -0.2% in 2023 from 3.4% in 2022.

"Fiscal support, excess consumer savings of 9.5% of GDP, and a tight labour market are likely to reduce the severity of the downturn," says Punhani.

The newly announced tax cuts are said to be worth 2% of GDP, implying a fiscal stimulus of around 7% of GDP over the next two years, according to Credit Suisse.