As members of the Bank of England’s monetary policy committee discussed another interest rate hike on Thursday, they had two new issues.
The nine MPC members, including BoE Governor Andrew Bailey, had to factor in the good news of a sharp fall in wholesale electricity prices and then fit the committee’s new pessimistic view of the UK economy’s prospects for growth without causing inflation.
The results were rather messy. Although the BoE’s new forecasts showed inflation to fall well below the central bank’s 2 percent target over the next year, MPC members voted by a seven-to-two majority to raise interest rates from 3.5 percent to 4 percent.
At a news conference, senior BoE officials justified the move as akin to buying insurance against future price increases — if inflation forecasts prove wrong. Consumer price inflation stood at 10.5 percent in December, down from a peak of 11.1 percent in October.
“It is too early to declare victory [over inflation] Not yet,” Bailey said. “We must be sure that we are indeed turning to deflation.”
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A majority of MPC members said in the minutes that they put more weight on strong wages and employment data and “relatively less [weight] In the medium-term projections for inflation
They added that the desire to be sure they beat inflation could lead to further rate hikes.
BoE Deputy Governor Sir Dave Ramsden said the MPC “must be used”. [the central bank forecasts] In a more subtle way than what we did in the first 10 years of the MPC”.
But forecasts suggest MPC members may not need to raise interest rates at their February meeting.
Whether looking at the MPC mode, the median or the average of forecasts, an interest rate of 4 percent leaves inflation very low in two years and very low in three years, with at least a 50 percent chance it will be below 1 percent.
George Buckley, chief UK economist at Nomura, said: “The bank’s end-of-horizon outlook for inflation [in 2026] remains exceptionally weak.”
The underlying message from the BoE inflation forecasts was that, if they were correct, interest rates could soon fall very quickly.
Bailey confirms this as a cyclical one, saying: “If the economy develops like the central sector [of the forecasts]We will frame the policy accordingly.”
But while the outlook for inflation was good, the BoE hike forecast was poor.
The IMF sent shockwaves across the Atlantic on Tuesday with a forecast that Britain’s economy will go into recession this year – and will be the only industrialized country to do so.
The BoE was not much different. Its forecast for 2023 was slightly worse than the IMF’s, with UK gross domestic product falling by 0.7 per cent in the fourth quarter from a year earlier. The BoE was also gloomy about 2024, with the central bank forecasting stagnation, while the fund expects growth of 1.8 percent.
KPMG economist Yael Selfin said the BoE’s short-term growth forecast would make difficult reading for Britons. The central bank “paints a bleaker picture for the UK economy, which is suffering stronger headwinds than its peers”, he added.
The BoE now expects a shorter and shallower recession than MPC members at the November meeting, but finer details show GDP is not expected to reach pre-Covid levels until 2026.
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Ben Broadbent, another BoE deputy governor, said the IMF was probably right in identifying the UK as having the weakest economic prospects among industrialized nations this year, although he added the differences were small.
He pointed to unique problems facing the UK in the short term, including declining participation in the labor market, particularly among older people. He also pointed to the UK’s higher reliance on natural gas than elsewhere in Europe, which would reduce British household incomes and translate higher interest rates more quickly into more expensive mortgages, which would reduce consumer spending.
“These are not things that will last forever,” Broadbent said, trying to sound reassuring about the prospect.
But the BoE’s long-term outlook was bleak. Underpinning MPC members’ views was new thinking that the UK could no longer sustain growth rates of 1 per cent a year without causing inflation. Previously, they thought annual growth of 1.5 percent would not cause inflation.
BoE officials did not try to downplay the difficulties of living in an economy that grew at an annual rate of 2.5 percent before the financial crisis and which could have sustained about 1.7 percent before the coronavirus hit.
Bailey blamed “changing trade relations with the EU”, including the impact of the pandemic and higher energy prices following Russia’s invasion of Ukraine, which had dampened UK productivity growth and reduced the size of the labor force.
The BoE acknowledges that, with few engines for growth, the UK situation will be difficult for households and companies, even if the central bank is able to consider cutting interest rates soon.
James Smith, director of research at the Resolution Foundation, a think-tank, said: “Households are living through a sharp two-year slump in living standards, and Britain is living through a 20-year growth stagnation — the worst since the war. “
