- Bank of England doesn’t expect interest rate hike until next year
- Recent economic data is putting pressure on the bank to reconsider its position
- BoE faces rising inflation, a tight labor market and soft GDP growth
Investors are focusing on this week’s Bank of England monetary policy committee meeting for signs that it may be forced to act sooner than expected, as data clouds the outlook for the UK economy.
Markets are predicting two interest rate hikes in the future, but the first is not expected until the third quarter of next year, while the BoE lost comfortably last month to an early end to its bond buying program.
However, UK inflation is rising at a rate that suggests price increases may not be as ‘temporary’ as predicted by the BoE, which could soon escalate the case for raising borrowing costs.
UK inflation rising faster than expected after record surge in August
The dismal economic data, as well as the emergence of the Covid delta variant, also calls into question the growth trajectory of the UK.
Added to this is the impact of supply chain constraints that have affected companies in various sectors and slowed everything from sales to manufacturing, as well as reports of staff shortages and problems in the energy market in various industries.
July saw a record jump in consumer price inflation, rising from the BoE’s target of 2 per cent to a nine-year high of 3.2 per cent.
The BoE has said it expects inflation to rise to around 4 percent by the end of 2021 before easing.
BoE Governor Andrew Bailey recently revealed that more than half of MPC members now believe the initial conditions to open up to the possibility of raising interest rates have been met. There are also two new members of the committee in the meeting to be held this month, adding to the uncertainty.
While markets do not expect the BoE to hike rates until next year, recent economic data may force action sooner rather than later.
Some aspects of the increase in inflation are ‘transient’, some ‘policy-driven, so may be more sustained’, explained Howard Cunningham, fixed income portfolio manager at Newton Investment Management.
However, Cunningham said it is unlikely the MPC will vote to raise rates early, noting that we have ‘yet to see the impact from the end of the furlough on activity and the labor market’, and the fact that ‘inflation’ For the most part it is supply-side rather than demand-led… so bringing forward an increase in interest rates may not help’.
He believes the MPC will remain in ‘wait and see mode’ on Thursday, withholding action until November when members have more ‘clarity’ on the outlook for the economy.
On the surface, the MPC also faces an improved labor market, with wages and unemployment returning to pre-pandemic levels.
But the well-publicized labor shortage in some areas, despite large numbers of workers being on leave, suggests a tighter labor market than it may appear.
Richard Woolenough, bond fund manager at M&G Investments, wrote in a blog last week that the BoE faces a “unique challenge” in trying to “understand the tightness of the UK labor market and post-Brexit inflationary effects”. .
The bank is facing not only a tight labor market data, he said, ‘but a booming housing market, while the market-implanted outlook for future 10-year inflation is towards its long-term high’. .
This, Woolnuff said, ‘shows that tightening UK monetary policy is firmly on the agenda’.
‘The old lady who is the Bank of England is likely to turn,’ he said.
GDP growth was quite disappointing in July, as the lifting of most COVID restrictions did not help meet expectations. GDP growth was projected to be 0.6 percent, but official figures showed a growth of only 0.1 percent.
Bank of England Governor Andrew Bailey recently revealed that half of the MPC now sees conditions for a potential interest rate hike.
Retail sales also declined for the fourth straight month in August, indicating that the UK economy may not recover as well.
Valentin Bissat, senior economist at Mirabaud Group, said ‘downside risks remain’, as ‘Covid-19 could weigh on growth, as well as other uncertainties associated with Brexit and supply chain disruptions’.
“Next week, the MPC will keep the policy unchanged during its policy meeting, but it will be interesting to see whether the emphasis will be on rising inflation or slowing growth,” he said.
Catherine Nees, chief European economist at PGIM Fixed Income, agreed the MPC could hold off on the change this week, but said the outlook for COVID-19 could put further pressure on the UK economy.
She explained: ‘Although the UK is advanced in terms of vaccination coverage, the impact of the delta variant on the rest of the world is expected to impact demand for UK exports.’
Can an increase in inflation lead to a stagflation or a growth spurt?
CPI inflation in August rose by the largest monthly amount on record to 3.2% – higher than expected and is projected to rise.
The lack of supply meeting the demand wall has been blamed for the rise of inflation, but other factors such as high energy prices and labor shortages continue to play out.
With rising costs, rising wages and warming demand, is the risk of inflation spiraling out of control to prompt the Bank of England to raise interest rates?
And is this just the beginning of a recovery that will eventually push the economy into a structural gear, or will growth slow and a gloomy report warning of stagflation prove accurate?
On this podcast, Georgie Frost, Lee Boyce and Simon Lambert discuss inflation and the supply crisis.
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