The Bank of England has pulled the trigger on another interest rate rise but its signalling will do little to assuage critics who think it is dangerously behind the curve on taming inflation.
An increase of 25 basis points to the UK’s main Bank rate is a return to the pre-pandemic level of 0.75 per cent and was widely anticipated by markets.
The decision was near unanimous, with eight out of nine rate-setters in favour and one, Sir Jon Cunlife, voting to keep rates unchanged. No member of the monetary policy committee was in favour of a rate rise greater than 0.25 percentage points.
The Russian war in Ukraine and the yet to be realised economic fallout has quietened the Bank’s hawks for now. In February, four members of the committee wanted to tighten at a more aggressive rate of 0.5 percentage points. It is the single biggest swing from hawkish dissent to doveish dissent since the financial crisis struck in 2007, according to Pantheon Macroeconomics.
The outlook for the global economy has deteriorated since the Bank’s February rate rise, with Russian tanks rolling into Ukraine weeks later. Food and energy prices are on the up, supply chains are continuing to be squeezed and the war is weighing down business and consumer sentiment.
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Projected UK inflation is expected to hit four times the bank’s target rate at 8 per cent by June, up from the peak of 7.25 per cent in April that was estimated last month. Prices will remain elevated for most of the year and could climb “several percentage points”, raising the spectre of double-digit inflation for the first time since Margaret Thatcher was prime minister in the 1980s.
In the trade-off between growth and inflation, the Bank is choosing to veer on the side of caution in the face of severe uncertainty on how events in Ukraine will affect the price of commodities such as grain, cereals, fertiliser, crude oil and natural gas. Hopes of a negotiated peace deal have gathered momentum in the past week and it would be a significant lift for the world economy if a ceasefire materialises.
In the absence of hard data on the impact of the war, Bank rate-setters chose to soften their language around rate rises this year. They warned that “further modest tightening in monetary policy might be appropriate in the coming months” — a change from the “likely” tightening suggested in February.
It is a far cry from the stance taken by the US Federal Reserve, which began an aggressive tightening cycle on Wednesday and signalled an additional six rate increases for the year. Even the European Central Bank delivered a surprisingly hawkish message this month, opening the door to exiting its mass bond-buying programme in the face of record inflation.
Unlike its fellow central banks, the Bank of England began acting before the Fed and the European bank in curbing inflation risks before the invasion of Ukraine. The rise announced on Thursday means it is the first time the Bank has carried out a third consecutive rate rise since it gained independence from the Treasury in 1997. The Bank has also led the way in “quantitative tightening” — the gradual shrinking of its balance sheet after more than a decade of bond purchases. It has promised to carry out active bond sales once the interest rate reaches 1 per cent, which is just one increase away.
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At the core of the Bank’s doveish assessment was the expectation that inflation would fall to just above its 2 per cent target in two years and slip below the mandate over the next three years. The judgment is based on market expectations for where interest rates are going, as well as a natural slowdown in household spending that comes with a squeeze on living standards.
“The judgment that inflation would fall back also reflected that monetary policy would act to ensure that longer-term inflation expectations were well anchored around the 2 per cent target,” the Bank said — a riposte to critics who think its credibility when it comes to curbing inflation is on the line.
Markets have responded by drastically reducing their rate expectations for the rest of the year to 1.75 per cent by September and 2 per cent by the end of the year, down from 2 per cent and 2.5 per cent respectively. It is the biggest drop in future rate expectations in over a decade, Samuel Tombs at Pantheon Macroeconomics said. “The tone of the vote and minutes caught markets off guard. The committee has never defined ‘modest’ but they surely do not share the markets’ view.”
On wage rises, the Bank in February warned that households were facing the steepest drop in disposable income since comparable records began 30 years ago. Estimated at about 2 per cent, this figure is set to decline to 4 per cent when the Bank updates its forecasts in May.
In light of the income squeeze, rate-setters have chosen to keep their powder dry just before the chancellor’s spring statement, passing the baton to the government to address the record tightening in living costs. It said: “This is something monetary policy is unable to prevent.”
