As members of the Bank of England’s Monetary Policy Committee deliberated on another interest rate rise on Thursday, they had two new issues to grapple with. The nine MPC members, including BoE governor Andrew Bailey, had to factor in the good news of a sharp fall in wholesale energy prices, and then fit this into the committee’s newly pessimistic view of the UK economy’s potential to grow without generating inflation. The result was rather messy. Although the BoE’s new forecasts showed inflation falling well below the central bank’s 2 per cent target by next year, MPC members voted by a majority of seven to two to raise interest rates from 3.5 per cent to 4 per cent. At a news conference, senior BoE officials justified the move as being akin to buying insurance against future price rises — just in case the inflation forecasts proved to be wrong. Consumer price inflation stood at 10.5 per cent in December, down from a peak of 11.1 per cent in October.“It’s too soon to declare victory [over inflation] just yet,” said Bailey. “We need to be absolutely sure that we really are turning the corner on inflation.”
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The majority of MPC members said in the minutes that they put more weight on strong wage and employment data and “relatively less [weight] on the medium-term projections” for inflation.They added that the desire to be absolutely sure they have defeated inflation might result in further rate rises. Sir Dave Ramsden, BoE deputy governor, said the MPC was “having to use [the central bank forecasts] in a more nuanced way than we did in the first 10 years of the MPC”. But the forecasts suggested MPC members need not have increased interest rates at their February meeting. Whether the MPC looked at the mode, the median or the mean of the forecasts, interest rates of 4 per cent left inflation too low in two years’ time, and much too low in three years’ time, with at least a 50 per cent chance it will be under 1 per cent. George Buckley, chief UK economist at Nomura, said “the bank’s end-horizon view for inflation [in 2026] remains exceptionally weak”.The underlying message from the BoE inflation forecasts was therefore that, if they turn out to be correct, interest rates could soon be falling quite quickly.Bailey confirmed this in a roundabout way, saying: “If the economy evolves as in the central case [of the forecasts], we will set policy according to that.” But if the outlook for inflation was good, the BoE growth forecasts were bad. The IMF had sent shockwaves across the Atlantic on Tuesday with a forecast that Britain’s economy would slide into recession this year — and be the only industrialised country to do so. The BoE did not differ much. Its forecast was slightly worse than the IMF for 2023, with a drop in UK gross domestic product of 0.7 per cent in the fourth quarter compared with one year earlier. The BoE was also gloomy about 2024, with the central bank predicting stagnation, while the fund expects growth of 1.8 per cent. Yael Selfin, economist at KPMG, said the BoE’s short-term growth forecasts would make difficult reading for Britons. The central bank “paints a gloomier picture for the UK economy, which is suffering stronger headwinds compared to its peers”, she added. The BoE now expects a shorter and shallower recession than MPC members did at their November meeting, but the fine details show that GDP is not expected to reach pre-coronavirus levels until 2026.
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Ben Broadbent, another BoE deputy governor, said the IMF was likely to be correct in singling the UK out as having the weakest economic prospects among industrialised countries this year, although he added the differences were small. He pointed to unique problems the UK faced in the short term, including declining participation in the labour market, especially among older people. He also highlighted the UK’s higher dependency on natural gas compared to elsewhere in Europe, which would continue to lower British household incomes, and the faster translation of higher interest rates into more expensive mortgages, which would lower consumer spending.“These are not things that will last for ever,” said Broadbent, trying to be reassuring about prospects.But the BoE’s long-term outlook was bleak. Underpinning the MPC members’ view was new thinking that the UK cannot sustain a growth rate of 1 per cent a year any longer without generating inflation. Previously, they thought annual growth of 1.5 per cent would not generate inflation.BoE officials did not try to downplay the difficulties of living in an economy that used to grow at an annual rate of 2.5 per cent before the financial crisis, and one that could sustain about 1.7 per cent before coronavirus. Bailey blamed “the change in the trading relationship with the EU”, along with effects from the pandemic and higher energy prices following Russia’s invasion of Ukraine, which had lowered UK productivity growth and reduced the size of the labour force. The BoE recognises that, with few motors for growth, UK conditions will be difficult for households and companies, even if the central bank is able to consider cutting interest rates soon. James Smith, research director at the Resolution Foundation, a think-tank, said: “Families are living through a sharp two-year living standards downturn, and Britain is living through a 20-year growth stagnation — the worst since the interwar years.” More
