Until recently, it looked all but certain that the Bank of England would lift borrowing costs from historic lows next Thursday.
Having blindsided investors by standing pat last month, the Old Lady of Threadneedle Street had been widely expected to become the first large central bank to raise interest rates since the pandemic struck.
Policymakers had sent clear signals. Huw Pill, the Bank’s chief economist, said that the ground had “now been prepared for policy action”. The nine-strong monetary policy committee had fretted over a possible jump in unemployment after the furlough scheme wound down in the autumn, but those fears had been dispelled, clearing the way for a base rate rise.
However, the pendulum has swung decisively in the other direction with the emergence of Omicron. To curb the spread of the variant, the government re-imposed restrictions this week. The measures could sap growth and confidence in the run-up to Christmas and a rate rise is now seen as a long shot.
“The new Omicron Covid-19 variant has complicated the MPC’s December decision,” Martin Beck, chief economic adviser to the EY Item Club, said. “The immediate and direct effect of the new variant’s discovery — a fall in oil and other commodity prices –— means the forces affecting inflation are no longer all pointing upwards and the variant poses numerous other challenges for the economic recovery.”
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Nor is the Bank alone in focusing on the issue. Finance ministers from the G7 group of nations, including Rishi Sunak, will meet virtually on Monday to discuss the recent jump in inflation.
A majority of economists, albeit a slim one, agree with the EY Item Club, a forecasting body, that the Bank of England is likely to keep rates on hold.
Changes since last MPC meeting
When the MPC shocked investors by holding rates steady last month, it argued that subdued growth and lower disposable incomes would tame the rapidly rising inflation rate. The committee said there was “value in waiting for more information” on the impact of the furlough scheme’s demise.
Since then inflation has risen to a ten-year high of 4.2 per cent and Ben Broadbent, a deputy governor, warned that the rise in the cost of living could exceed 5 per cent next year — against the Bank’s target of 2 per cent.
Crucially, the labour market has continued to strengthen. Wage growth is picking up and vacancies rose to record highs, in a sign that companies are having to pay to attract and keep skilled staff. Surveys suggest the cull of furloughed workers has not materialised.
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However, Omicron has weakened the case for an immediate base rate increase. “The MPC does not yet know how transmissible Omicron is, the extent to which it evades vaccines and whether it will force the government to impose restrictions that are stricter,” Ruth Gregory, at Capital Economics, said.
Ratesetters have a barrage of data to consider, including employment and average earnings figures for October and inflation data for November. But with today’s GDP figures showing the recovery running out of steam, the pressure to tighten policy is receding.
Who are the key figures?
Michael Saunders, an external MPC member, was one of two ratesetters who voted to raise rates last month.
In a recent speech, he hinted that he may switch sides, arguing that there could be “particular advantages in waiting to see more evidence” on Omicron’s effects on the public health and the economy. However, Saunders warned that a continued delay in raising rates could be “costly”.
Andrew Bailey, the governor, described last month’s decision as a “close call” and said the economy was still feeling the after-effects of the pandemic.
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Broadbent said in a speech this week that the inflationary pressures from rising energy bills and imported goods could dissipate over the next couple of years. However, he identified the tight labour market as a possible source of a more persistent rise in the cost of living.
Other MPC members appear less worried about short-term inflationary pressures, such as rising energy bills. Catherine Mann, an external member, said late last month that it was “premature to . . . even talk about timing [of a rate rise], much less how much”. Silvana Tenreyro, another outside MPC member, said that she would focus on the “medium-term” outlook.
What does the market say?
A small majority of economists believe that the Bank will keep policy unchanged at the MPC meeting. In a Reuters poll this week, 25 economists expected rates to remain at 0.1 per cent versus 21 who predicted a rise to 0.25 per cent. Investors are even more sure the MPC will stand pat. Trading in interest rate futures shows that the market ascribes a 25 per cent chance of a rise to 0.25 per cent. Before Omicron emerged, the probability stood at more than 75 per cent.
Is bank’s credibility at stake?
Bailey was accused of sending equivocal signals to investors before last month’s meeting. In October he appeared to set the scene for a rate rise, only for the MPC to pull its punch. The episode revived memories of the “unreliable boyfriend” jibes aimed at Mark Carney, his predecessor.
At a hearing last month he insisted that the Bank was in the “price stability business” and gently chided investors for taking the MPC’s “conditional statements and turn[ing] them into an unconditional view of the world”.
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The Bank, in other words, will change its mind when the facts change. And while a rate rise seems unlikely next week, economists still expect the MPC to tighten policy at its February meeting and to lift the base rate to 0.5 per cent by the middle of next year.
