Another hike in UK interest rates was already underway before Queen Elizabeth’s death delayed the Bank of England’s decision. In any case, the pause has made the pleas for rapid monetary tightening even clearer – the only question is how far policymakers will go at their Thursday meeting.
The big change since the BoE Monetary Policy Committee last met in early August is new Prime Minister Liz Truss’ plan to cut energy bills for households and businesses, at an estimated cost of £150 billion. This will lead to inflation falling faster in the coming months, but the plan amounts to a massive fiscal stimulus that is likely to keep inflation higher in the medium term unless the MPC takes steps 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 would affect inflation “in the longer term.”
Financial traders are betting that the MPC will react even more aggressively to high inflation this week than it did in August, when interest rates were raised 0.5 percentage points to 1.75 percent — the strongest rise in 27 years. Now market prices imply a larger increase of 0.75 percentage point, peaking at 4.5 percent next year.
However, members of the MPC are likely to split over the magnitude of monetary tightening. With the UK economy hovering on the brink of recession, at least one member, Silvana Tenreyro, has chosen a more moderate line and could vote for a 0.25 percentage point increase, while others are likely to favor a second consecutive rise in 0.5 percentage point. Analysts said it was unclear what the majority of MPC members will decide.
One argument for the BoE to go big is that it runs the risk of appearing indecisive compared to its peers. The European Central Bank raised interest rates this month for the first time since the introduction of the euro by 0.75 percentage point. Meanwhile, on the eve of the MPC’s decision, it appears that the US Federal Reserve will see a 0.75 percentage point increase for the third time in a row. If the BoE is seen as a laggard, it could exacerbate the sell-off of the pound sterling — which hit its 37-year low against the dollar on Friday — and increase inflationary pressures.
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“The MPC is currently in a corner and needs to raise bank rates quickly to prevent the pound from depreciating further and to let households know that tackling inflation is serious,” said Samuel Tombs of the consultancy Pantheon Macroeconomics. , who nevertheless argued that the inflation outlook was improving and that policymakers did not have to strangle the economy with a continued series of large rate hikes.
Other analysts believe that inflationary pressures in the UK economy are still mounting, with data released last week showing that sluggish manufacturing and falling retail sales are pushing up service prices, or accelerating nominal wage growth, into a booming labor market, have not stopped.
“If there have been lingering surprises in wage and price data since August, aggressive central banks in developed markets, a weaker currency, a gilded market and . . . fiscal easing is not pushing the MPC to ramp up its tightening pace to 75 basis points. . . it’s hard to see what that would do,” said Allan Monks, an economist at JPMorgan.
Policymakers will also be concerned about declining public confidence in the BoE’s response to rising inflation. While UK consumer price inflation declined slightly to 9.9 percent in August on the back of 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 inflation. back in the medium term.”
Others, however, think that policymakers will be more cautious and will be content with a 0.5 percentage point increase for the time being. While the new direction of government fiscal policy is clear, the MPC will meet Friday before Chancellor Kwasi Kwarteng outlines details of Truss’ proposed tax cuts and the cost of the Treasury’s energy support package, and policymakers will only be able to include these in their November projections.
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Fabrice Montagné, an economist at Barclays, said a sudden deterioration in business sentiment showed that the economic slowdown was broadening, and that “the arguments of the most moderate [MPC] members tastier”.
Another question is whether the MPC will still go ahead with plans to begin reducing the stockpile of assets it has amassed under quantitative easing programs, as it had indicated in August — given the possibility that the government will sell major bonds while easing its fiscal stance.
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Whatever the MPC decides on Thursday, many analysts believe it will have to continue raising interest rates for longer than they seemed likely in August, due to developments in energy markets and government fiscal stimulus.
“Even if the bank doesn’t raise as far as markets expect, we think the advent of government stimulus means the BoE won’t race for rate cuts next year, unlike some of its developed-market counterparts,” said James Smith. economist at ING.
“Liz Truss’ policies are likely to cause the bank to raise interest rates faster and further,” said Paul Dales of the consulting firm Capital Economics, which now expects interest rates to rise to 4 percent.