In an effort to combat rapid price rises in Britain, the Bank of England raised interest rates on Thursday, its first back-to-back increases in more than 17 years, and said it would start to shrink its enormous holdings of government and corporate bonds.
Inflation is already at its fastest pace in three decades: The annual rate rose to 5.4 percent in December. But by April the central bank expects it to climb to about 7.25 percent, the highest projection the bank has ever made. In response, the policymakers voted to raise interest rates by 25 basis points to 0.5 percent.
But four of the nine policymakers wanted to do something bolder: a 50-basis point increase, a move twice as big. The bank has never approved a rate increase that large before.
The Bank of England raised interest rates in December for the first time in three and half years, looking past the economic uncertainty created by Omicron and focusing on the battle against inflation.
In the end, the bank only expects Omicron to have weighed on Britain’s economy in December and January, whereas inflation is proving a much more persistent problem. Inflation far exceeds the central bank’s 2 percent target and even after it’s expected to peak in April will stay above 5 percent for the rest of the year.
Half of the increase in inflation between now and April will be because of higher energy prices, the Bank of England said. Earlier on Thursday, Ofgem, Britain’s energy regulator, announced that the price cap on energy bills would rise by 54 percent in April for 22 million households. The government has said it will try to mitigate the pain by giving millions of households £350, or $476, off bills this year in the form of grants and loans.
The rest of the projected inflation increase over the next three months is expected to be split between higher prices for goods and services.
One of the major concerns for policymakers is that businesses and consumers will begin to assume that rapid cost increases will continue, causing workers to demand higher wages in response and businesses to continue to raise their prices, fueling a cycle that keeps inflation rates higher for longer.
In January, Catherine Mann, a member of the bank’s rate-setting committee, said it was the job of monetary policy to “lean against” expectations that could lead to this scenario.
But there are already signs it is happening. The central bank’s economists expect wage settlements to rise by nearly 5 percent over the next year, based on surveys with businesses it consults.
Still, prices are rising faster than wages. For months, the higher inflation rates have prompted concerns about a cost-of-living crisis in Britain, as the budgets of households, particularly low-income ones, are squeezed by the most rapid food price inflation in a decade, higher energy bills and other rising costs.
The squeeze is set to be even worse than the central bank projected just three months ago. For 2022, the bank’s measure of net income after taxes and inflation is expected to fall by 2 percent from last year, and fall again in 2023. In November, the central bank had projected a 1.25 percent decline in 2022.
Since 1990, that measure of income has only fallen twice before on an annual basis, in 2008 and 2011.
But eventually the squeeze is destined to hamper the overall economy. Growth in gross domestic product is “expected to slow to subdued rates,” according to the minutes of rate-setting meeting which concluded on Wednesday. “The main reason for that is the adverse impact of higher global energy and tradable goods prices” on incomes and spending. The central bank also expects it to push the unemployment rate back up to 5 percent, after falling to 3.8 percent in the first quarter.
That economic slowdown is expected to push inflation back below the central bank’s target by 2024.
On Thursday, policymakers also voted to begin reducing the bank’s bond holdings. The bank will stop reinvesting the proceeds from bonds that mature in their holdings, which are made up of £875 billion in government bonds and £20 billion in corporate bonds. Over the course of this year and next year, £70 billion in government bonds will mature and shrink the size of the bank’s balance sheet. The bank will also sell its corporate bond holdings over the next two years.
Source: Economy - nytimes.com
