The BoE seeks to prove that it is in the “business of price stability”
Bank of England Governor Andrew Bailey on Thursday insisted the central bank had no choice but to raise interest rates, saying if it hadn’t done anything, it would risk that inflation would constantly remain too high.
It was the BoE that implemented its new slogan that it is “in the realm of price stability”, given that consumer price inflation is currently peaking at 5.1% in ten years. years, compared to the central bank’s 2% target.
But the first interest rate hike in more than three years has posed two questions: why tighten monetary policy now rather than early next year, when economic uncertainty triggered by the new variant of the Omicron coronavirus may have faded? And what impact will a small rate hike of 0.15 percentage point, to 0.25 percent, have on the economic recovery and people’s lives?
With the BoE’s Monetary Policy Committee having surprised financial markets and economists for two consecutive meetings, holding rates in November and then raising them on Thursday, Bailey will be aware that he is seen as an unpredictable communicator on monetary policy.
Allan Monks, an economist at JPMorgan, summed up the MPC rate hike as the “right move, wrong month”, saying the action would have made a lot more sense in November, when inflation was already on the rise and Omicron was not on the radar.
The BoE has dismissed these criticisms. Instead, his reasoning can be summed up by answering three “D’s” that have occurred in the past six weeks.
First, new data suggests that the inflationary threat has intensified. Second, the new deliberations of the nine MPC members show them concerned about the prospect of persistent price growth. Third, further discussions with business have highlighted the need to act quickly.
The data the BoE highlighted came mainly from the labor market, where MPC members noted that there were “few signs” that the end of the government leave scheme in September had weakened demand for workers, reinforcing their view that “the labor market is tight and has continued to tighten”.
The MPC’s continued underestimation of inflation this year has also focused people’s minds, with members now expecting the annual rate of price growth to peak at around 6%, down from 4% in their forecast earlier. at four months.
This caused a change in the deliberations of the MPC. Instead of trying to explain the high price growth as “transient” or “temporary”, members accepted that above target inflation is likely to persist.
And while members still expect the inflation rate to fall again in the second half of 2022, they now fear that businesses and workers will respond to cost increases by raising prices and wage demands.
The MPC now expects commodity price inflation to remain “well above” pre-pandemic levels in the coming months. He expects service inflation to “rise a little further” and food prices “to rise further, reflecting cost increases in recent months.”
One of the things that has most alarmed MPC members has been the regular discussions it has with companies across the UK, including through its survey of business decision makers.
All of this suggested that inflation was likely to be persistent, with companies saying they had already increased their prices by almost 5% in the past year and planned to increase them an additional 4.2% by November 2022. .
The BoE’s survey of policymakers also suggested that nearly 60% of companies find it “much more difficult than usual to recruit” employees. The greatest pressures came from sectors with well-known labor shortages: hospitality, transport and logistics.
If the three Ds explained the MPC’s new concern about the persistence of inflation and the vote by eight against one of its members to raise rates, the increase of 0.15 percentage point appears small compared to the problems identified by the BoE.
Higher interest rates normally work by seeking to restrain spending by businesses and households, in part by increasing the cost of borrowing, thereby reducing demand and returning it to production that the economy can provide without being produced. prices do not increase excessively.
An interest rate of 0.25% will not make much of a difference directly, given that the vast majority of mortgage borrowers now have fixed rate loans. Charles Roe, Director of Mortgages at UK Finance, a professional body, said: âOver 74% of mortgage customers have purchased a fixed rate product and will not see any immediate change in their mortgage payments. “
The rate hike was therefore designed more as a wake-up call for businesses and workers, so that they do not factor higher inflation into pricing and wage decisions in the months to come.
To deter people from thinking that the BoE will allow high inflation to persist, the MPC said there were “strong arguments” for immediate monetary policy tightening as well as further “modest” increases future rates “in order to maintain price stability in the medium term”.
âMaintain the current stance of monetary policy when CPI inflation was significantly above the 2% target. . . could lead to a further drift in medium-term inflation expectations, âhe added.
George Buckley, an economist at Nomura, who correctly predicted the BoE would act on Thursday, said the signal on rates was much larger than how much they had increased.
“The bank clearly did not want to be in a position in two to three months, where inflation has risen further, the virus is on the decline again, but it has failed to get key rates off the ground,” he said. -he adds.