Bank of England: Policy convergence questions after Fed hike – Standard Chartered

Standard Chartered’s Christopher Graham examines whether the Bank of England will feel pressured to follow the Federal Reserve’s September rate hike. He notes that Fed tightening alone does not force the BoE to act and stresses the role of UK data and market credibility. Historical evidence shows increased policy convergence, but past cycles demonstrate that BoE moves are not automatic.

Fed move and BoE policy sensitivity

"The FOMC raised its policy rates by 25bps on 16 September, its first hike since August 2023. The next day the Bank of England (BoE) held its policy rate at 3.75%, unchanged since late last year. A question we have been asked recently is whether the BoE will feel compelled to tighten policy purely as a result of the Fed’s decision, especially given our expectation of a further 25bps hike at the FOMC’s December meeting (see FOMC – Moderate statement, hawkish presser’)."

"Evidence points to increased policy convergence between the Fed and the BoE since the turn of the millennium; this can be explained by the increased importance of global factors. In a speech from earlier this year, MPC member Megan Greene noted that “the ‘global rate factor’ explained just over 10% of the variation in domestic policy rates between 1970 and 1999, but this has increased to 38% since 1999”. The pre-GFC and post-COVID hiking cycles are clear examples of convergence, but the BoE moved first in both cases."

"However, the Fed’s 2016-19 hiking cycle shows that convergence is not automatic: the BoE cut rates post-Brexit owing to concerns over demand, only to increase them modestly a year later."

"Fed tightening, in and of itself, does not compel the BoE to follow suit. However, the importance of the market credibility channel should not be understated. UK data flow is ultimately decisive; for now, this leads us to favour a BoE hold, but it is a close call"

"The macroeconomic rationale for the BoE’s sensitivity to Fed tightening can best be explained via the exchange rate channel. Higher US interest rates attract capital inflows, leading to relative GBP weakness and an increase in imported inflation."