The Bank of England has backed away from an immediate rise in interest rates, leaving the benchmark at the historic low of 0.1 per cent even as it published its highest inflation forecast for a decade, predicting it would reach 5 per cent in the spring of next year.
The bank’s Monetary Policy Committee said it was likely interest rate rises would be needed “over coming months”. But the level of urgency was dialled down compared with governor Andrew Bailey’s comments during October that the committee “will have to act” to restrain inflation.
The decision to keep interest rates on hold confounded financial markets, which were convinced the BoE was poised to raise rates, to 0.25 per cent, for the first time since 2018.
Sterling fell 0.8 per cent to $1.3572 after the announcement, down from $1.364 before the announcement. Short-term UK government debt rallied, pushing the two-year bond yield 0.3 of a percentage point lower to 0.62 per cent.
The MPC attempted to quell market disquiet with signals that it would still need to increase interest rates close to 1 per cent by the end of 2022 to keep inflation under control.
Traders are now betting on a rate rise to 0.25 per cent at the MPC’s December meeting.
The BoE’s monetary policy decisions were not unanimous. Two of the nine MPC members voted for an immediate rate rise to 0.25 per cent and three of the members wanted the bank to end its quantitative easing programme of asset purchases immediately.
But they were outvoted by a large majority, including Bailey, who took the view that subdued economic growth and expected falls in real household incomes would help pull inflation sharply lower in the second half of next year.
The majority said there was no need for an immediate interest rate increase because “there was value in waiting for more information” on the effects of ending furlough in the labour market and to reflect a “moderation in demand” which might persist amid pressures on household incomes.
Higher inflation “was still most likely to prove transitory”, according to the majority, “leading to a one-off increase in consumer prices rather than persistently higher inflation rates”, and they worried about the costs of a small increase in interest rates.
But in a bid not to be seen to have misled markets, the whole committee reiterated the message that interest rates were soon likely to rise.
“Provided the incoming data, particularly on the labour market, were broadly in line with the central projections in the November monetary policy report, it would be necessary over coming months to increase Bank Rate in order to return CPI inflation sustainably to the 2 per cent target,” the MPC said in a statement.
With its inflation forecast, the MPC signalled that interest rates would need to move to a close to 1 per cent over the course of the next year.
The inflation forecast remained well above the committee’s target for three years when it based the figures on interest rates remaining at the current rate of 0.1 per cent, while it fell back to just below target when the BoE assumed interest rates rose to 1 per cent by the end of 2022.
The committee expected supply chain disruption to persist to the end of next year and energy prices to rise further, pushing inflation up to 5 per cent in April before falling back. But it did not expect inflation to fall below 3 per cent until the spring of 2023, leaving an uncomfortably long period of inflation well above target.
This long spell of high inflation prompted two members of the MPC — Michael Saunders and Sir Dave Ramsden — to vote for interest rates to rise to 0.25 per cent and quantitative easing to end immediately. They judged “inflation was likely to remain above the 2 per cent target in the medium term”, with greater pass through of higher costs to prices and risks the BoE would have to raise interest rates further in future to tame price rises.
A rate rise now, they said, “would demonstrate the committee’s commitment to returning inflation to target in the medium term and help to ensure that medium-term inflation expectations remained well anchored”.
Catherine Mann joined the two dissenters in voting to end quantitative easing immediately.
Source: Economy - ft.com
