UK interest rates: Push for sharper rise flags scale of troubles: Ian McConnell

We have in recent months had some split votes on rates in which some members have preferred to hang fire, while others have wanted to implement an immediate increase.

In contrast, the five-to-four vote last week which saw UK base rates rise from 0.25% to 0.5% was not split on whether the Bank of England’s Monetary Policy Committee should push benchmark borrowing costs higher following the increase from 0.1% in December.

Rather, the split in the vote was around the scale of the rise in interest rates. Four MPC members judged that a half-point increase in base rates was warranted at last week’s meeting. Such a move, and it was not that far off happening in terms of the split of the vote, would have been the biggest single rise in rates since the Bank of England became operationally independent a quarter-century ago.

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The vote for a half-point rise by the four members surprised many observers, and this is understandable particularly given the recent history. That said, you can see plenty in the numbers which would make monetary policy-makers contemplate whether sharper rises in rates now might help prevent inflationary problems becoming embedded or limit the extent to which this occurs.

We look, unfortunately, to be in a very different situation from an inflationary perspective to that during the recovery from the global financial crisis. Then, in spite of the huge monetary policy stimulus put in place including massive amounts of quantitative easing which understandably make many experts nervous, inflation did not become a major problem.

Obviously, there has been much about the recovery so far of the economy from the pandemic impact which has been far less difficult than the road back from the global financial crisis. The availability of bank funding has been far less of a problem so far this time round and the labour market situation which, while not ideal in terms of huge part-time working and likely under-employment, is far less bad than many would have feared at the onset of the pandemic. However, all of that said, inflation is now a very big problem with great potential to derail recovery.

Setting out the view of Jonathan Haskel, Catherine L Mann, Dave Ramsden and Michael Saunders, in their vote for a half-point rise in UK base rates last week, the minutes of the MPC meeting state: “Four members judged that a 0.5 percentage point increase in Bank Rate was warranted at this meeting. Monetary policy had been very accommodative, and capacity pressures were now widespread, especially in the labour market.”

Writ large in the Bank’s monetary policy summary, which accompanied news of the rise in base rates last Thursday, was the degree to which inflation had continued to surprise on the upside.

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Annual UK consumer prices index inflation, which was only 0.4% in February last year, rose from 5.1% in November to 5.4% in December, 2.7 times the Bank’s 2% target. The December rate was the latest in a string of inflation numbers to have exceeded economists’ forecasts.

Not only that, but the projections of the Bank of England and others of where inflation will peak have just kept getting higher.

Household energy bills are obviously a key part of the trouble but it is crucial to realise the inflationary problems are very broadly based.

The minutes of last week’s MPC meeting state: “Twelve-month CPI inflation had risen to 5.4% in December, almost one percentage point above the November [monetary policy] report forecast. The upside news had been spread across a number of components, particularly within core goods.

“Strength in core goods prices, alongside higher energy prices, had also accounted for much of the absolute overshoot in inflation relative to the 2% target. Services price inflation had moved further above its pre-Covid rate. Price increases had been particularly acute for second-hand cars and hospitality, replicating trends in the United States.”

And the Bank’s revised inflation outlook published last week, crucially the expectation inflation will now peak at around 7.25% and the fact this forecast high is around two percentage points greater than the projection just three months earlier, highlights the difficulties ahead.

The Bank said: “Inflation is expected to increase further in coming months, to close to 6% in February and March, before peaking at around 7.25% in April. This projected peak is around two percentage points higher than expected in the November report. The projected overshoot of inflation relative to the 2% target mainly reflects global energy and tradable goods prices.”

Reflecting on the rapid deterioration in the inflation outlook, it should perhaps have been less of a surprise that four MPC members voted for a half-point rise in rates.

Setting out the view of these four MPC members, the minutes state: “The projected path for CPI inflation was again being revised up over the first two years of the forecast period, while medium-term inflation expectations remained relatively high and on some measures had increased further.

“Companies responding to the decision-maker panel had indicated that they expected to raise prices significantly in 2022. The strong pick up in pay settlements reported to the Bank’s agents, and the recent broadening from goods price to services price inflation, suggested that these developments were now being reflected in domestic costs and prices, which could make CPI inflation more persistent than was expected in the February report central projection.

“Monetary policy should tighten to a greater extent at this meeting in order to reduce the risk that recent trends in pay growth and inflation expectations became more firmly embedded and thereby help to bring inflation back to the target sustainably in the medium term.”

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All of this provides plenty of food for thought.

Bank of England Governor Andrew Bailey last week sparked furore by calling for workers to show “restraint” on pay demands.

The minutes state the five MPC members voting for a quarter-point rise in rates, including Mr Bailey, “recognised the risks from the possibility of stronger domestic wage and price pressures in the near term, but also saw a need to balance this against the potential for inflation to fall more quickly and to a greater extent than expected if energy and other tradable goods prices followed a lower path than in the MPC’s central projection”.

And, perhaps more interestingly in terms of an insight into these five members’ views, the minutes add: “There was also a case for moving Bank Rate in small increments; a larger increase at this meeting could have an outsized impact on expectations for the further path of policy, which was already sufficient, in the central projection, to push inflation well below the target in year three of the forecast.”

The minutes not surprisingly signal further rises in base rates, declaring: “The MPC judged that, if the economy developed broadly in line with the February report central projections, some further modest tightening in monetary policy was likely to be appropriate in the coming months. The committee continued to judge that there were two-sided risks around the medium-term inflation outlook, primarily from wage developments on the upside and from energy and global tradable goods prices on the downside.”

For many households struggling under the weight of inflation, further interest-rate rises are about the last thing they need. However, it is a most difficult juggling act for policy-makers, exacerbated dramatically by the string of nasty upside surprises on the inflation front.

It is also worth noting, when contemplating the scale of the problem, that UK inflation on the old all-items retail prices index measure still preferred by some is now 7.5%. That is a sobering figure indeed.