Bank of England policymakers will be under pressure to step up the pace of monetary tightening when they meet this week, following the lead set by the European Central Bank and US Federal Reserve.
BoE governor Andrew Bailey has made it clear that while a 0.5 percentage point increase in interest rates is “not locked in”, it will be “among the choices on the table” when the monetary policy committee makes its policy decision on Thursday. The BoE has raised interest rates in 0.25 percentage point increments since December but pledged in June to act “forcefully” if needed in response to more persistent inflationary pressures.
If the MPC follows though, raising the central bank’s benchmark rate to 1.75 per cent, it will be the sharpest increase in borrowing costs for more than a quarter of a century.
Analysts say the decision will be finely balanced, as policymakers weigh relentless inflationary pressures against the rising risks of recession. But a growing number of forecasters think the balance of opinion on the MPC will swing in favour of the first 50 basis point rise since its independence.
“After the ECB and the Fed delivered oversized hikes at their July meetings, the Bank of England is likely to feel similar pressure,” said Amarjot Sidhu, economist at BNP Paribas.
Philip Shaw, at Investec, said the BoE “may fear a credibility problem if it is perceived to be lagging behind its peers”.
The IMF, which slashed its global growth forecasts this week, pointed to the UK as one of the countries where the outlook for inflation had worsened most. It urged policymakers to take “decisive action” even if it hit growth, jobs and wages in the short term — arguing that a gradual approach would simply lead to a more disruptive adjustment later.
“If the BoE continues to rise by 25 basis points per meeting, it would be outpaced by most other central banks,” said Fabrice Montagné, economist at Barclays, adding that the pound’s 3 per cent depreciation since April reflected a perception by markets “that the UK is falling behind”.
Inflation, which reached 9.4 per cent in June on the CPI measure targeted by the BoE, has so far risen largely in line with the central bank’s May forecasts. But the latest surge in gas prices means the BoE’s new projections are likely to show it climbing even further into double digits than was already expected in the autumn, when the cap on regulated energy prices will rise again.
The MPC cannot do anything about high energy prices, but it will worry about the knock-on and potentially lasting effects on business and household behaviour — which it can influence.
Meanwhile, recent data suggest economic growth has held up better than the BoE expected in the second quarter of 2022. At the same time, employment has continued to grow strongly, against a backdrop of continuing labour shortages that have underpinned rapid nominal wage growth.
Policymakers said in June that the “scale, pace and timing” of any further rate increases would reflect their assessment of the economic outlook — and that they would be “particularly alert” to any signs of more persistent inflationary pressures.
“The MPC is faced with the prospect of higher and more persistent inflation and an economy that is slowing but not crashing. So another rise in interest rates looks inevitable,” said Andrew Goodwin, at the consultancy Oxford Economics. He is among those economists who still think the BoE will stick to a more conventional 0.25 per cent increase, but acknowledged it could easily justify a bigger move.
Policymakers may also be worried that the tax-cutting pledges of Liz Truss, the frontrunner in the Conservative leadership race, will lead to a fiscal splurge later in the year — forcing them to raise rates further — although the BoE could only factor this into its forecasts once it had become government policy.
Alongside its decision on interest rates, the BoE is also set to give more details of its plans to start selling some of its gilt holdings, potentially preparing to vote in September and begin sales the following month. However, Bailey has signalled that the BoE wants interest rates to remain its main tool for tightening monetary policy, with a steady unwinding of quantitative easing taking place in the background.
The big question for investors, though, is whether a larger move from the BoE would be a one-off or the start of an aggressive tightening cycle.
At present, traders are betting that interest rates will peak close to 3 per cent early in 2023, implying at least two more 0.5 percentage point increases by the end of this year.
Most analysts think this is going too far, noting the BoE has repeatedly signalled that inflation would fall below its 2 per cent target in the medium term if interest rates rose in line with market pricing.
“Recession risks are clearly mounting and that’s the most obvious reason for the bank to stop tightening by the autumn . . . by the fourth quarter, we’re likely to see the full effect of the cost of living squeeze,” said James Smith, economist at ING, adding that while the rise in energy and food prices was “eye-watering”, broader inflationary pressures were already starting to cool.
Paul Dales, at the consultancy Capital Economics, is one of the few forecasters to share market expectations that interest rates will reach 3 per cent, but he too said that despite more aggressive moves made by other central banks, a 50bp increase “may be the MPC’s top speed”.
Source: Economy - ft.com
