Pressure mounts on Bank of England for big interest rate hike

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Another UK interest rate hike was already expected before Queen Elizabeth’s death delayed the Bank of England’s decision. On the contrary, the pause has made the case for rapid monetary tightening even clearer – the only question is how far policymakers will go when they meet on Thursday.

The big change since the BoE’s Monetary Policy Committee last met in early August has been new Prime Minister Liz Truss’ plan to cap household and business energy bills, at an estimated cost of £150billion. . This will cause inflation to fall faster over the next few months, but the plan amounts to a huge fiscal stimulus that will likely keep it higher over the medium term unless the MPC acts to offset it.

“We have work to do,” Huw Pill, the BoE’s chief economist, told MPs after Truss’ energy measures were announced, adding that the MPC would focus on how they affected inflation “to longer horizons”.

Financial traders are betting the MPC will act even more aggressively in response to high inflation this week than it did in August, when interest rates were raised by 0.5 percentage points to 1.75 %, the largest increase in 27 years. Now market prices imply a bigger rise of 0.75 percentage points, with rates peaking at 4.5% next year.

However, MPC members should be divided on the extent of monetary tightening. With the UK economy on the brink of recession, at least one member, Silvana Tenreyro, has taken a more dovish line and may vote for a 0.25 percentage point hike, while others are likely to favor a second successive increase of 0.5 percentage points. Analysts said it was unclear what the majority of MPC members will decide.

One of the arguments for the BoE to get big is that it risks looking irresolute relative to its peers. The European Central Bank raised interest rates by 0.75 percentage points this month for the first time since the launch of the euro. Meanwhile, the US Federal Reserve is expected to register a third straight increase of 0.75 percentage points on the eve of the MPC decision. If the BoE is seen as a laggard, it could deepen the selloff in sterling – which hit a 37-year low against the dollar on Friday – adding to inflationary pressures.

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“The MPC is stuck in a corner at the moment and needs to raise the Bank Rate quickly to prevent the pound from depreciating further and to signal to households that it is serious about fighting inflation,” said Samuel Tombs of consultancy Pantheon Macroeconomics, who nevertheless argued the outlook for inflation was improving and that policymakers did not need to “strangle the economy” with a sustained series of sharp rate hikes.

Other analysts say inflationary pressures continue to build in the UK economy, with data released last week showing stagnant output and falling retail sales failed to stem higher prices for services or the acceleration of nominal wage growth in a dynamic labor market.

“On persistent surprises in wage and price data since August, hawkish central banks in developed markets, a weaker currency, a government securities market sell off and. . . fiscal easing does not push the MPC to accelerate its rate of tightening to 75 basis points . . . it’s hard to see what would happen,” said Allan Monks, an economist at JPMorgan.

Policymakers will also worry about declining public confidence in the BoE’s response to soaring inflation. Although consumer price inflation in the UK fell slightly to 9.9% in August due to lower petrol prices, it remains the highest in the G7.

The MPC “needs to be bolder to restore its credibility”, said Julian Jessop, a fellow at the Institute of Economic Affairs, a think tank, arguing that a 0.75 percentage point increase would “send a stronger signal that the bank is serious about getting inflation back down in the medium term”.

Others, however, think policymakers will be more cautious and settle for a 0.5 percentage point hike for now. Although the government’s new fiscal policy direction is clear, the MPC will meet on Friday before Chancellor Kwasi Kwarteng presents details of Truss’ proposed tax cuts and the costs of the Treasury’s energy support package, and the decision-makers will only be able to integrate them into their forecasts in November.

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Fabrice Montagné, an economist at Barclays, said a sudden turnaround in the business climate showed the economic downturn was spreading, and that “should make the arguments more dovish”. [MPC] limbs more palatable”.

Another question is whether the MPC will continue with its plans to start reducing the stock of assets it has accumulated under quantitative easing programs, as it signaled in August – given the possibility that the government launches major bond sales as it eases fiscal policy. .

Whatever the MPC’s decision on Thursday, many analysts believe it will have to keep raising interest rates for longer than expected in August, due to developments in energy markets and fiscal stimulus. of the government.

“Even if the bank does not rise as much as markets expect, we believe the arrival of government stimulus means the BoE will not rush to rate cuts next year, unlike some from its developed market counterparts,” said James Smith, an economist at ING.

“Liz Truss’ policy will likely make the bank more likely to raise rates faster and further,” said Paul Dales of consultancy Capital Economics, who now expects interest rates to rise to 4%.

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