The Bank of England could be forced to raise interest rates to 5% this summer, Goldman Sachs has warned, as Britain struggles to bring down the highest rates of inflation among the G7 group of advanced economies.
Threadneedle Street is widely expected to increase the cost of borrowing for households and businesses on Thursday for a 12th time in succession, with financial markets anticipating a quarter-point rise to 4.5%.
However, the US investment bank warned that households and businesses could face further increases in the cost of borrowing as the central bank struggles to bring down the highest rates of inflation in 40 years to more sustainable levels.
It comes with inflation stuck in double digits after falling by less-than-expected in March, standing at 10.1%, as British households grappled with the fastest annual rise in food and drink prices since 1977.
Inflation sticking at higher levels than expected would maintain pressure on households amid the cost of living crisis and could prove embarrassing for the government, after Rishi Sunak’s pledge to halve the rate of inflation this year. The inflation rate stood at 10.7% when he made the promise.
Goldman said that although UK inflation was on track to fall rapidly, helped by cooling global energy prices, the measure for the rising cost of living was unlikely to drop enough to meet the Bank’s 2% target set by the government.
Ibrahim Quadri, an economist at the US investment bank, said: “While it is possible that the [Bank’s rate-setting] monetary policy committee might want to slow the hiking to a quarterly pace after the May meeting, we remain sceptical that this will be feasible amid ongoing inflationary pressures.
“We therefore expect the monetary policy committee to continue to hike in 25 basis point steps until reaching a terminal rate of 5% in August.”
Financial markets expect the central bank to increase rates above 4.5% this year, although they are not pricing in the likelihood of rates hitting 5%. Some economists have also argued that Threadneedle Street could pause its rate-hiking cycle after this week’s meeting.
Central banks around the world have increased borrowing costs sharply to tackle soaring inflation after the Covid pandemic and Russia’s war in Ukraine. The head of the European Central Bank, Christine Lagarde, warned last week that it had “more ground to cover” after raising rates to 3.25%.
The head of the eurozone’s central bank said inflation across the 20-nation bloc remained “too high”, while warning that companies were taking advantage of high inflation to push through price increases.
In the US, investors are betting that the Federal Reserve could be forced to cut rates this year amid the fallout from the worst banking crisis since the 2008 crash. The Fed raised rates last week to 5% to 5.25%. However, the US economy has proven resilient in recent months, including figures last week showing a stronger-than-expected 253,000 rise in employment in April.
The likely Bank of England rate increase comes as households and businesses across the UK come under growing pressure from past rate rises, with millions of borrowers who fixed their mortgages and loans at lower rates coming to the end of these deals. About 1.4 million households’ fixed rate mortgages are due to expire this year.
However, Britain’s economy has performed more strongly than expected in recent months amid resilient levels of consumer spending and rising business confidence despite the cost of living crisis.
Goldman said the Bank was likely to significantly upgrade its growth projections, amid expectations the UK is likely to avoid a prolonged recession.
“We think the UK can avoid a deep recession. The growth picture is a more constructive one than the Bank of England has been painting,” said Jari Stehn, Goldman Sachs’ chief European economist.
With companies struggling to fill vacancies, the US bank said wage growth in the UK was likely to remain more robust than expected, in a development that it said was probably incompatible with Threadneedle Street’s 2% inflation target.
It said inflation was on track to fall to about 4.2% by December, significantly higher than the 2.9% forecast made alongside the government’s spring budget in March by the Office for Budget Responsibility.
