The Bank of England has said that “some modest tightening of monetary policy is likely to be necessary” over the next two years to keep inflation under control.
In a hawkish change in the stance of the central bank’s Monetary Policy Committee, a majority of its eight members indicated at their meeting that ended on Thursday that they thought the economic conditions had been met to allow it to start discussing raising interest rates again.
The move came in response to new BoE forecasts showing that inflation was likely to rise to 4 per cent towards the end of this year, compared with a previous forecast of only 2.5 per cent, and there would be excess demand for much of the next year.
Sterling rose after the decision, but was only 0.22 per cent higher on the day against the US dollar an hour after the meeting at $1.392.
Krishna Guha, vice chair of Evercore ISI, said the BoE “has come out more hawkish than expected, starting to build the case for tightening over the medium term in spite of near-term disruption from the Delta variant of the virus, which it assessed would have only a ‘slightly negative’ impact on third-quarter growth”.
But there was no urgency in the MPC for immediate action. The committee voted seven to one to continue the £150bn programme of purchases of government debt until the end of the year and unanimously to keep interest rates at the historic low of 0.1 per cent.
Most of the increase in inflation, the BoE said, was still “transitory” and the rate of price growth would fall sharply next year because energy prices would not rise further and supply bottlenecks in semiconductors and other goods were likely to ease.
The BoE’s forecasts showed that only very gradual interest rate rises were likely to be necessary to keep inflation close to its medium-term target of 2 per cent, with the first increase to around 0.25 per cent likely to come next year before rates reach 0.5 per cent in 2024.
The minutes of the August meeting highlighted how a majority of the MPC had come to the view that inflation was now likely to be sufficiently strong to meet the 2 per cent target “sustainably” and the committee could begin to talk about tightening rates.
The minutes said that while “some” on the committee thought the conditions had not quite been met, “the other members of the committee judged that the conditions of the existing policy guidance had been met fully . . . but noted that the guidance had made clear that these had only ever been necessary not sufficient conditions for any future tightening in monetary policy”.
In a further clarification of its longer-term strategy for tightening monetary policy, the BoE announced that its first move would be to raise interest rates until they were 0.5 per cent and, once at that level, it would no longer reinvest the proceeds of the £875bn of government bonds it holds once they matured.
This was a decision to lower the interest rate at which it begins to unwind quantitative easing, partly, it said because it was now able to set a negative interest rate if it wanted and partly because it expected the market impact of ending the reinvestment of maturing gilts to be small.
It added that “the MPC will consider actively selling some of the stock of purchased assets only once bank rate has risen to at least 1 per cent”. But it said it would monitor the effect of this new policy carefully so that it would always aim to hit the 2 per cent inflation target.
Source: Economy - ft.com
