The Bank of England will need to demonstrate its plans to keep a lid on inflation at its monetary policy meeting this week, economists said, after the central bank failed to forecast the strength of the rebound in prices and growth this year.
Following last week’s move by the US Federal Reserve to publish projections showing it was likely to raise interest rates at least a year earlier than previously thought, all eyes this week are on the BoE to see whether it follows suit.
Pressure is mounting from central bank watchers and internally for the BoE to take a more proactive stance.
George Buckley, chief UK economist at Nomura, said that although he did not expect the central bank to act on Thursday, “the ongoing and sharp rebound in gross domestic product, alongside upside surprises in inflation, cannot be ignored”.
According to Philip Shaw, head of the economics team at Investec, “a US-style situation may be developing, where inflation rises more rapidly than the central bank is forecasting”.
The BoE has not had to face a situation when its assessment of the economy appears significantly wrong since the pandemic started, but the realisation that it will need to revise its view is now widespread, including within Threadneedle Street.
Andy Haldane, the bank’s outgoing chief economist, writing in the New Statesman earlier this month warned that the inflation outlook was its most dangerous for almost 30 years.
Inflation in the UK has jumped from 0.4 per cent in February to 2.1 per cent in May, a much faster rise than the BoE expected. The bank’s February forecasts show the Monetary Policy Committee expected inflation to reached around 1.6 per cent by May and these forecasts were revised higher last month to 1.8 per cent ahead of the release of the official data last week.
The BoE’s repeated underestimates of inflation has led financial markets to price in the highest rate of medium-term inflation since the financial crisis 13 years ago.
Calculations from UBS, which take account of changes to the measurement of the retail price index from 2030, suggest financial markets are expecting the medium term rate of inflation targeted by the BoE to be more than 1 percentage point above its 2 per cent target.
“If it rises much further as the economic recovery unfolds, the MPC will come under increasing pressure to convince the market it will keep a firm grip on future inflationary pressures,” said John Wraith, a strategist at UBS.
Few, however, expect the MPC to make a decisive move at the June meeting which wraps up on Thursday. Economists are almost unanimous in expecting the bank to continue with its latest £150bn round of quantitative easing until the end of 2021 and keep interest rates at the historic low of 0.1 per cent.
The question for many is whether the MPC chooses this month to talk about the increasing pressures it faces with inflation or whether it will continue to tough it out.
Sanjay Raja, economist at Deutsche Bank, said the BoE faced “challenges” from higher inflation but was unlikely to change its view that these were “transitory” at the meeting. However, he believed the change in the outlook should “tilt the policy statement in a slightly more hawkish direction than in May”.
Christian Schulz of Citi added that policymakers would need to demonstrate some concern so as not to look complacent. “We expect some other signs of vigilance probably in the minutes, but the guidance to be unchanged,” he said.
Most economists now expect a significant overshoot of inflation later this year. But many agree with BoE officials that prices will come under control again automatically in 2022 because unemployment will rise once the coronavirus furlough scheme ends, while spending growth will soon moderate.
Thomas Pugh at Capital Economics said there was “enough spare capacity in the economy to bring inflation back down”. The delay in the final reopening of the economy would mean the rapid spending growth seen lately would “slow significantly over the summer”, according to Samuel Tombs, UK economist at Pantheon Macroeconomics.
But the increasing talk of tighter monetary policy will be difficult for the BoE to ignore, especially as it is reviewing whether it would seek to raise interest rates or reverse QE. Andrew Bailey, BoE governor, has hinted that he would like to sell some bonds the bank holds, reversing QE, sooner rather than later.
This has led financial markets and economists to be unsure what will happen to interest rates with economists expecting the first rise at some time between the start of 2022 and 2024. Financial markets are betting on the second half of 2022.
Richard Barwell, head of macro research at BNP Paribas Asset Management, said the lack of clarity in the BoE’s intentions had backfired and left financial markets assuming a more hawkish stance than the central bank probably desired. “It’s unclear what they want to do and how they will do it. The MPC should be concerned that markets will price in more hikes,” he said.
Source: Economy - ft.com
