For the Bank of England and its under-fire governor Andrew Bailey, the central bank’s half-percentage-point rise in interest rates was an attempt to finally get on the front foot in the fight against high inflation.
The BoE aimed to banish its timid image on curbing price rises, in which it appeared to follow rather than lead events. The central bank instead sought to be decisive in its efforts to get a grip on inflation.
The change of tack on Thursday was clear both in the BoE Monetary Policy Committee’s decision on interest rates and its explanations.
The MPC raised rates more than financial markets had expected, to 5 per cent. It made no attempt to cushion the blow for households, with Bailey giving the tough message that despite the pain looming for households with mortgages, “if we don’t raise rates now it could be worse later”.
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And Bailey and his fellow rate-setters did not push back against markets’ predictions that the BoE benchmark interest rate will peak at about 6 per cent.
Chancellor Jeremy Hunt weighed in behind the governor, saying the BoE had his “full support” and needed to tackle inflation “relentlessly”.
Senior figures in the Treasury expect inflation to come down from 8.7 per cent in May to the BoE’s 2 per cent target within 18 months.
The problem for the BoE, as its officials acknowledged in private, is that this is not the first time the central bank has attempted to restore its credibility in fighting inflation.
The past two-and-a-half years have been very difficult for the BoE, especially as what was a global inflation problem is now lasting longer in the UK than elsewhere.
The central bank’s actions and communications have regularly looked far too complacent about price rises since the start of 2021.
BoE officials scoffed at Andy Haldane, the central bank’s then chief economist, after he warned in February 2021 that an inflationary “tiger” was stirring in the UK economy.
Officials refused to halt the BoE’s quantitative easing unleashed during the Covid pandemic when it became inappropriate as price rises accelerated in the summer of 2021. Taking his cue from the US Federal Reserve, Bailey spoke of “transitory” inflation for much of that year.
In October 2021, the BoE hinted it was about to raise interest rates, then backed off. When it did start to raise rates that December, Bailey talked for months about walking along a “narrow path” between curbing high inflation and unleashing a recession.
The central bank’s forecasts have persistently underestimated the peak and duration of the period of high inflation.
For most of 2022 the BoE warned about the possibility of a wage-price spiral — when companies increase the price of their products in response to rising costs, prompting workers to demand pay rises in a repeating, self-fulfilling process — without noticing it had already started.
The BoE finally acknowledged this error last month, but still managed to be overly optimistic in its forecasts for wages and prices before Bailey admitted inflation was taking “a lot longer” than hoped to come down.
When some of these errors were pointed out to the governor in a testy news conference in May, the governor rounded on journalists for “using the language of blame”.
Over time, MPs and the public have noticed the BoE’s mis-steps. With mortgage rates rising back to levels recorded in the aftermath of Liz Truss’s disastrous “mini” Budget, the central bank’s survey of public attitudes this month found a record level of dissatisfaction with its efforts to curb inflation.
Worse, an Ipsos opinion poll this week showed most people surveyed thought BoE decisions had contributed to the soaring cost of mortgages — with more pinning the blame on the central bank than the government, Brexit or Russia’s full-scale invasion of Ukraine.
The question after Thursday’s surprise interest rate rise is whether the BoE has restored its credibility or whether this is viewed as a panic move, reflecting its weakness.
Bailey and the BoE will be pleased with market reaction, which was muted in the afternoon following the rate decision.
The value of sterling and yields on government bonds barely changed, with market expectations for the peak in interest rates also registering little movement.
But not all the commentary after the MPC meeting was favourable. Julian Jessop, fellow at the Institute of Economic Affairs, a think-tank, said: “A more credible central bank might have been able to leave interest rates on hold today.”
Henry Cook, senior economist at MUFG, the investment bank, said: “The decision to move back to a larger [interest rate] increment is a tacit admission that policymakers have got it wrong on inflation.”
Others warned that the BoE might now be willing to kill the economy in a bid to restore its own standing.
Martin Beck, economic adviser to the EY Item club, said: “If the MPC’s concern about regaining ‘credibility’ causes policymakers to focus too little on what’s to come and too much on what’s already passed, monetary policy could be tightened unduly, pushing the economy into an unnecessarily substantial downturn.”
However, much of the commentary by economists was neutral about Bailey and the BoE, with analysts preferring to plump for a figure for how high rates are likely to go.
There were some positive reviews that raised the possibility that the BoE might have got it about right, just as Bailey did during the pension fund crisis last October following Truss’s “mini” Budget.
Ellie Henderson, economist at Investec, said: “Today the Bank of England successfully managed to increase the bank rate by 0.5 percentage points without triggering panic in markets and a sense of ‘When will this end?’, which was a concern of ours heading into the [MPC] meeting.”
Jamie Niven, senior fund manager at Candriam, the asset manager, added: “While a hawkish surprise, [the rate rise] may result in a return of credibility to the bank.”
Bailey and the other eight MPC members will hope more people come round to this view in the coming weeks.
Source: Economy - ft.com
