THE BANK OF ENGLAND has sprung its second surprise in as many months. In November it failed to raise interest rates after it had steered markets to expect an increase. On December 16th it did raise rates after all, surprising investors—despite the most obvious change in the economic outlook being a worsening of the pandemic. The bank’s monetary policy-committee voted by a margin of eight to one to raise interest rates from 0.1% to 0.25%. That makes Britain the first big rich economy to experience interest-rate rises since the pandemic struck.
A defence of the Bank of England’s toing-and-froing would start with the argument that now is an exceptionally tricky time to be doing its job. The global economy has been battered by a series of unusual shocks. With the state of the economy so uncertain, investors should not expect clear predictions about the path of policy. Indeed, the minutes of the bank’s meeting said that the decision was “finely balanced”.
The motivation for the rate rise is, in part, a worry that uncomfortably high inflation might stick. The bank’s decision came a day after the publication of inflation figures for November. Consumer prices rose at an annual rate of 5.1%, higher than economists had expected, and well above the bank’s target of 2%. The bank expects inflation to stay at around 5% throughout most of the winter, peaking at 6% or so in April 2022. Although it saw few signs of inflation expectations spiralling out of control, it saw signs of “greater persistence in domestic cost and price pressures”.
Moreover, there are indications that Britain’s labour market is making a rapid recovery. The latest data show that it has shrugged off the end of the country’s furlough scheme with little fuss. Wages are growing faster than they were before the pandemic, and unemployment has fallen more quickly than expected. Maintaining very loose monetary policy could therefore risk juicing up an economy already at full capacity, fuelling future price rises that would be painful to bring under control.
The main surprise was not the fact that the Bank of England chose to raise interest rates—in November it had said that it would do so “over coming months”. Instead it was the timing. Britain is in the throes of an enormous wave of infections caused by the Omicron variant of covid-19. To be sure, that could exacerbate inflation problems, if it means that people continue to splash their cash on goods rather than services, in turn extending retailers’ supply-chain woes. But if fiscal support is not forthcoming, confidence takes a knock and spending slumps, inflation could start to flag.
Although successive waves of the virus have caused decreasing damage to the British economy, this one could buck that trend if vaccines prove less effective at stopping its spread. Silvana Tenreyro, the lone dissenter on the committee, pointed out that Britain’s economy was still smaller than it had been before the pandemic. Although the new variant could raise inflationary pressures, she argued, there were scenarios in which sticking with rock-bottom interest rates would be best.
The Bank of England has been more hawkish than other big central banks like the Federal Reserve or the European Central Bank. On December 15th the Fed indicated that it would start raising interest rates next year. The ECB, which met on the same day as the Bank of England, announced a reduction in its overall asset purchases but gave no hint that interest-rate rises were imminent. The Bank of Japan, due to meet on December 17th, is expected to stand pat. The obvious risk is that, by being the first to raise rates, the Bank of England has to change course if the recovery falters. There could be more surprises to come. ■
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Source: Finance - economist.com
