Lenders in focus after Bank’s stagflation warning

Alongside a big rates rise, the Bank of England has shocked the City with a gloomy view on 2023. How have banking shares and currency markets reacted?

Bank of England projections warning of a recession lasting five quarters jolted financial markets today as the pound fell sharply and banking stocks weakened.

The dire forecasts from the Bank, which included an expected peak for CPI inflation of 13.3% in October, came alongside the first half-point increase in interest rates since 1995.

The Bank has already increased rates five times since December, with today’s move resulting in the highest level since 2009 at 1.75%. But a similar hike in September is on the cards after the Bank vowed to act ‘forcefully’ in the fight against high inflation.

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That raises the alarming prospect of a further aggressive tightening of monetary policy just as the UK is projected to enter a recession from the final quarter of this year.

Economists at ING said: “The fact that the Bank is stepping up the pace of rate hikes, while also forecasting a meaningful recession shows just how worried it is that worker shortages and supply issues could keep inflation elevated even as the economy weakens.”

Currency markets took a dim view of developments as growth-focused sterling sold off 0.5% in the moments after the Bank’s rates decision and outlook statement.

That provided some support for the FTSE 100 index due to its international focus and high number of dollar-earning stocks. In a stronger session for European markets, the top flight stood 31 points higher at 7,477 by mid-afternoon.
 
This improvement masked an earlier wobble for banking stocks as the gloomy economic forecasts took some of the shine from the sector’s recent earnings season and the positive impact of another margin-enhancing increase in interest rates.

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NatWest (LSE:NWG) shares jumped by 10% at one point on Friday after its interim results included £2.1 billion of shareholder returns and no obvious signs of stress among its customers.

Shares were trading at 252p in the minutes prior to the Bank of England decision, buoyed by earlier favourable broker comment as Goldman Sachs included the lender on its “conviction buy list” with an increased target price of 410p.

Deutsche Bank’s banking analyst Robert Noble also increased his estimate by 50p to 380p. He said: “NatWest's target for a 14-16% ROTE (return on tangible equity) in 2023 is a substantial upgrade to consensus and makes NatWest the most profitable of the large-cap UK banks.”

NatWest shares weakened to 247.8p immediately after the Bank statement but later recovered to 250p. Lloyds (LSE:LLOY), whose shares are trading without the right to its latest dividend, also lost a penny shortly after noon.

The FTSE 250 index, which is more exposed to the fortunes of the UK economy, continued its recent rebound by adding another 168 points to 20,186. But Redrow (LSE:RDW) was one of the stocks on the fallers board, mirroring declines for Taylor Wimpey (LSE:TW.) and Barratt Developments (LSE:BDEV) in the FTSE 100 index as investors worry about a hard landing for the housing market.

The Bank of England’s forecasts now point to a 2.2% decline in GDP spread over the five quarters from the end of 2022. That’s a deeper and longer recession than the 1% decline over four quarters forecast by Capital Economics.

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Its chief economist Paul Dales said: “Overall, the Bank is forecasting stagflation and suggesting that in the near term the medicine is the tough love of higher interest rates and that further ahead the comfort blanket of interest rate cuts may be needed.

“Our forecast is that rates may have to rise to 3% early next year to ensure that price/wage expectations fall back to levels consistent with the 2% inflation target. ”

ING, however, expects another big rates hike in September but thinks that may be the last.

Its economist James Smith said: “The window for further hikes further appears to be closing, not least because outside of the jobs market, there are signs that some of the key inflation drivers may be starting to ease.”