The Bank of England is set to raise interest rates to its highest level since 2008 on Thursday, following last month’s official data that showed inflation remains stubbornly high.
The expected increase in borrowing costs will represent the 12th consecutive increase by the central bank since it began raising rates in December 2021. This comes after similar moves by the US Federal Reserve and the European Central Bank.
Economists will look beyond the rate decision in the Monetary Policy Committee’s announcement, which was finely balanced against future tightening at its last meeting in March, and its new economic forecasts to try to gauge how much higher interest rates could rise further.
How much is MPC expected to raise rates?
Economists and markets almost universally expect a quarter percentage point increase from 4.25% to 4.5%.
Growth was far from a foregone conclusion after the MPC’s March meeting, when the committee said it would continue to track “evidence of a more sustainable [inflationary] pressure” before increasing interest rates again.
But last month, official data showed that March inflation was 10.1 percent, much higher. Bank of Englandthe forecast was made in February, when it was expected to weaken to 9.2 percent. Combined with increased pressure on wages and stronger economic data, economists believe the evidence threshold has been reached.
Bruna Scarica, a British economist at Morgan Stanley, said she believes the inflation figures have been a game-changer with the “stickiness of basic commodities.” [inflation]despite rather weak retail sales volumes.
George Buckley, chief economist at Nomura in the UK, said the chances of the Bank of England doing anything other than a 25 basis point rate hike are “very low”. He added: “Prices assume that the markets think the same way.”
What will happen to the forecasts of the Bank of England?
The starting point for the Bank of England will be higher-than-expected inflation for March. Officials are still expected to see price pressures ease rapidly throughout 2023 as last year’s sharp rise in energy prices falls out of the annual comparison.
While the initial inflation rate in May is forecast to be worse, lower-than-expected energy prices will lower MPC inflation expectations even faster than forecast in February. This, in turn, will increase the income of the population.
The spot price of natural gas is currently 82p a therm, less than half the market price of 189p that the Bank of England used for 2023 in its February forecasts. At the end of 2024, the current price of the futures is 147 pence for the term, not 174 pence three months ago.
Buckley said falling energy prices would allow the Bank of England to drop its forecast that the economy would fall into recession this year.
But a better outlook would also create a problem for the central bank, as it would have to explain why it is raising interest rates when its model’s central outlook is likely to show lower medium-term inflation pressures.
Officials justify this approach by pointing to signs of “second-round” effects, economists’ jargon for what most people call the wage-price spiral. But they are not clearly defined in the BOE model, and Jumana Salekhin, chief economist at Vanguard Europe, said some MPC members “underestimated the transfer [recent] high rates of inflation are being introduced into the economy.”
Problems with the central bank model became apparent in February when officials decided to add 0.8 percentage points to its results to arrive at what they called a risk-weighted “arithmetic mean” forecast. This approach resulted in the largest deviation from the central MPC forecast.
Economists believe the adjustment factor could be even larger this time around, reflecting the concern of some committee members that high inflation is increasingly infiltrating the daily lives and pricing decisions of companies.
Will central bank leadership change?
One thing’s for sure, MPC won’t want to tie its hands and rule out a future rate hike. Officials are expected to signal that future changes in interest rates will be “data dependent” and that there has been no bias towards further policy tightening or rate reversals and rate cuts.
Members of the MPC are increasingly concerned about the threat posed by the wage/price spiral. Late last month, Bank of England chief economist Hugh Pill told households and companies they “should have accepted” that they were poorer as a result of higher energy prices. Central bank officials said they were closely monitoring companies’ pricing decisions.
Ashley Webb, a British economist at Capital Economics, said the MPC should have communicated the need to make borrowing more expensive for companies and households, rather than urging people not to ask for higher wages or try to protect profit margins.
“Since the bank started raising interest rates from 0.1% in December 2021 to 4.25% now, it has constantly warned that rates will not rise very far. If the bank had sounded more hawkish, perhaps price and wage expectations would have dropped even further,” he said.
Given the uncertainty, MPC is also likely to reveal the risks it faces regardless of its interest rate decision.
“The MPC has always used a risk-based approach, or at least should have done so,” to minimize the chance of large and persistent errors, said Jagjit Chadha, director of the National Institute of Economic and Social Research.
If the MPC raises interest rates too far before economic growth and inflation are affected, there is a risk that MPC members will look like “fools at heart,” said Silvana Tenreiro, an outside committee member who has consistently voted against the rate hike. . . . She warned that further tightening of monetary policy could trigger a sharp downturn.
But hawks fear the risk is that the MPC will move too slowly and fail to bring inflation back to the Bank of England’s 2 percent target.
During much of the period when interest rates began to rise, financial markets were a better guide than economists or Bank of England officials in forecasting the likely rapid rise in interest rates in the short term.
Although the BoE is not expected to signal a need for rate hikes in the future, traders continue to bet on further tightening as the futures market indicates that the cost of borrowing will be around 5 percent by the end of the year.