The Bank of England has warned that inflation will rise more sharply than expected but has defied market expectations by keeping interest rates unchanged at record lows.
Consumer price inflation is now forecast to peak at its highest level in a decade and reach about 5 per cent in April, driven up by surging gas and electricity prices. The Bank also cut its outlook for economic growth to account for continued turmoil in supply chains and estimated that UK gross domestic product had grown by 1.5 per cent in the third quarter, down from the 2.9 per cent expected in August.
Yet despite the rise in inflation expectations, the Bank’s nine-strong monetary policy committee voted to keep the bank rate at 0.1 per cent, although the MPC added that an increase would likely “be necessary over coming months”. This will confound financial markets, which had been pricing in a 15 basis-point rise in the benchmark rate to 0.25 per cent today.
The pound fell more than 1 per cent against the dollar to $1.3512 and by 0.8 per cent against the euro to €1.1695. Bank shares, which would have benefited from a rise, fell heavily with Lloyds Banking Group, Natwest and Barclays down between 3.2 per cent and 4.5 per cent. However, the FTSE 100 edged up from 7,248 just before midday to 7,283. The FTSE 250 gained 1.9 per cent to 23,558.
The ratesetters’ decision was not unanimous, however, the vote being split seven to two. The last time the MPC voted in September all nine committee members had wanted to leave rates unchanged.
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The two dissenters at the latest ratesetting meeting were Sir Dave Ramsden, a deputy governor at the Bank, and Michael Saunders, an external member of the MPC. They were in favour of a 15 basis-point rise because they judged that inflation was likely to remain above the Bank’s 2 per cent target in the medium term. They argued that lifting rates now would avoid the risk of “a more abrupt subsequent tightening in policy” at a later date, according to the minutes of the meeting.
Expectations have been growing in recent weeks that Threadneedle Street would become the first of the world’s big central banks to lift interest rates since the start of the coronavirus pandemic, when they were cut to 0.1 per cent to support the economy. Market speculation of a rate rise was fuelled last month by Andrew Bailey, the Bank governor, who said that the Bank “will have to act” to contain inflation.
Spiralling energy prices, labour market shortages and crunches in supply chains have conspired to drive up inflation in recent months, raising fears that households face a cost-of-living crisis. The consumer prices index stood at 3.1 per cent in September and the Office for Budget Responsibility, the government’s fiscal watchdog, warned last week that inflation could rise above 5 per cent next year.
In the Bank’s last monetary policy report in August it had forecast that consumer inflation would hit 4 per cent in the fourth quarter. This was revised at the last MPC meeting in September, when the Bank said that it would rise to “slightly above” that level in the final three months of the year.
Yet in the Bank’s latest quarterly report it lifted its inflation forecast to 4.5 per cent in November and December. “Primarily reflecting higher gas and electricity prices, inflation is then expected to rise further, peaking at around 5 per cent in April 2022,” the report said. The last time the Bank’s forecast has been this high was in August 2011 and inflation peaked at 5.2 per cent the following month.
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As in September, Ramsden and Saunders also voted at the latest MPC meeting to tighten policy by stopping the Bank’s huge quantitative easing programme early by cutting government bond purchases to £855 billion instead of £875 billion.
They were joined this time by Catherine Mann, an external MPC member who, according to the meeting minutes, “judged that it would be appropriate to remove some of the monetary stimulus stimulus to asset prices”. The trio were outvoted by the other six ratesetters.
Despite voting to keep rates at rock bottom lows, the ratesetters “judged that, provided the incoming data, particularily 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 unemployment rate fell to 4.5 per cent in the three months to August, the Bank said, from 4.6 per cent in the quarter to July.
It said that despite the wind down of the government’s furlough scheme at the end of September “there had continued to be few signs of increases in redundancies and the stock of vacancies had increased further, as had indicators of recuitment difficulties”. Threadneedle Street is forecasting that unemployment will only “rise slightly” during the final quarter.
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Paul O’Connor, at Janus Henderson, said: “The question is why has the governor sounded so hawkish over the last couple of months when in speech after speech he has clearly nudged market expectations higher.”
Andrew Sentance, a former ratesetter and a member of The Times shadow monetary policy committee, tweeted: “It is clear from the decision of the MPC to hold interest rates at an emergency rate of 0.1 per cent - despite surging inflation, skill shortages, etc - that they have no clue about how to handle monetary policy in current circumstances.”
However, Samuel Tombs. chief UK economist. Pantheon Macroeconomicsm said that the committee had played it safe by opting to wait for key labour market data, relating to the period since the furlough scheme has been wound down, to be published just before its next meeting on December 16.
He said: “If that data are ‘broadly in line’ with the MPC’s forecasts in November’s monetary policy report, the committee thinks “it would be necessary over coming months to increase the Bank rate in order to return CPI inflation sustainably to the 2 per cent target. We continue to expect the MPC to hold tight again in December and wait until February to hike Bank Rate, but the call remains finely balanced.”
Paul Dales, Chief UK Economist, at Capital Economics. said: “The MPC pushed back fairly strongly against the markets’ current rate expectations. It drew attention to its forecast that based on the markets’ rate expectations, it thought that CPI inflation would be just below the 2 per cent target in three years’ time, at 1.95 per cent, and a margin of spare capacity will open up by then. In contrast, the CPI inflation forecast based on rates staying at 0.10 per cent was much higher at 2.57 per cent. This suggests that the MPC thinks rates need to rise, but that they don’t need to rise as far as 1 per cent by the end of next year.”
