Bank of England UK interest rates tough talk unconvincing

The Old Lady of Threadneedle Street declared last Thursday: “Monetary policy will need to be sufficiently restrictive for sufficiently long to return inflation to the 2% target sustainably in the medium term, in line with the committee’s remit.

“As illustrated by the November monetary policy report projections, the committee continues to judge that monetary policy is likely to need to be restrictive for an extended period of time. Further tightening in monetary policy would be required if there were evidence of more persistent inflationary pressures.”

The last rate rise was in August but the MPC is continuing to flag the possibility of another increase if required.

Not only that but the pattern of voting remained hawkish.

While six MPC members including Bank of England Governor Andrew Bailey voted to stand pat on rates last week, three pushed unsuccessfully for a quarter-point rise to 5.5%.

External members Megan Greene, Jonathan Haskel and Catherine Mann also tried unsuccessfully at the MPC’s November and September meetings to push rates higher.

In short, it was all rather hawkish last week from the Bank of England.

The central bank’s stance seems increasingly detached from the views of a significant number of senior economists who see a danger of the interest-rate medicine being overdone.

This detachment was thrown into stark relief on Wednesday this week, when official data revealed annual UK consumer prices index inflation had tumbled by much more than expected, to 3.9% in November from 4.6% in October.

Financial markets moved to fully price in a rate cut by May and a near-50% probability of a reduction by March, in the immediate wake of publication of the inflation figures.

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It seems financial markets and some senior economists alike think the Bank of England’s bark on the future path of interest rates will prove to be much worse than its bite.

The Bank of England noted in its monetary policy summary last week that annual UK CPI inflation had fallen “sharply”, to 4.6% in October from 6.7% in September.

It said: “Since the MPC’s previous decision, CPI inflation has fallen back broadly as expected, while there has been some downside news in private sector regular AWE (average weekly earnings) growth.”

However, it added: “Key indicators of UK inflation persistence remain elevated. As anticipated, tighter monetary policy is leading to a looser labour market and is weighing on activity in the real economy more generally. Given the significant increase in Bank Rate since the start of this tightening cycle, the current monetary policy stance is restrictive.”

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This brings us to the heart of the controversy over the current policy on interest rates, with not only trade unions but also some senior economists believing the MPC should be cutting rates.

Some experts understandably feel that much of the hike in interest rates we have seen so far has yet to feed through.

UK base rates have been increased from a record low of 0.1% in December 2021.

The Bank of England continues to highlight inflation risks. And the UK’s inflation crisis has been woeful.

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However, former MPC member Danny Blanchflower has highlighted the peculiarity of the UK’s inflation situation, arising from the country’s hard Brexit.

He wrote in The Herald in June: “Brexit and its devastating impact on supply chains, especially for food, is what sets the UK apart from every other country. This can't be fixed by rate rises.”

There is obviously a cost of interest rates being too high, in terms of unnecessary unemployment and a needless extent of dampening of growth.

Returning to last Thursday, the response of some economists to the fresh messaging on interest rates from the Bank of England was fascinating.

Martin Beck, chief economic adviser to the EY ITEM Club think-tank, said: “Following comments from MPC members in recent weeks playing down the prospect of near-term rate cuts while arguing that monetary policy had become restrictive, it was no surprise that December’s meeting kept Bank Rate unchanged at 5.25%.”

Observing the tone from the MPC, he added: “The outcome of December’s vote wasn’t the only similarity with the recent past. The language of the latest policy statement repeated the ‘sufficiently restrictive’ for ‘an extended period of time’ rhetoric of last month’s minutes, characterising December’s decision as another hawkish hold. The message continues to be that rate cuts are seemingly a long way off.”

However, Mr Beck declared that “the EY ITEM Club thinks otherwise”.

He said: “The Bank of England’s latest inflation forecast, which raised the Bank’s expectations for inflation next year, had already looked on the high side, given a recent run of downside surprises. And developments since that forecast was published - a fall in oil and gas futures prices (the latter to the lowest in almost two years), a rise in the value of the pound and a slowdown in private sector pay growth - mean the Bank of England’s projection is looking even more pessimistic.

“Meanwhile, an unexpectedly large fall in GDP in October, and an absence of growth since early 2022 is indicative of the impact of past rate rises building.”

Mr Beck noted “services inflation has been held up by factors including strong growth in rents and mandated price rises in sectors such as telecommunications, which aren’t necessarily reflective of underlying economic conditions”.

He observed: “Underlying price pressures are easing and should continue to do so, reflecting a sluggish economy and the lagged impact of less expensive energy filtering through to services firms. On the wages front, growth is slowing and this trend should continue as the jobs market loosens and lower inflation means workers and employers feel less need to negotiate bumper pay rises.”

And he declared: “The EY ITEM Club thinks events will compel the MPC to change its tone as we move into the new year. Signs of such a shift may start to become apparent when the committee meets next in February and the EY ITEM Club continues to think that the MPC will go for the first rate cut in May. This should be followed by three further reductions over the remainder of next year, adding up to a cumulative 100bps (basis points) fall in Bank Rate in 2024. In that event, one of the key headwinds facing the economy will ease.”

Following the inflation data on Wednesday, the EY ITEM Club said the figures supported its view that “it won’t be long before the MPC starts to rein in its hawkish rhetoric, with rate cuts expected to commence next spring”.

Danni Hewson, head of financial analysis at stockbroker AJ Bell, noted last Thursday in the wake of the Bank’s monetary policy announcement that “even with three members of the MPC still voting for an interest-rate hike, nothing was going to take the fizz out of markets”.

She added: “Investors have felt the cool wind beneath their wings and there’s mounting expectation that the reality of rate cut timings won’t meet the rhetoric, with markets betting on the first cut as early as May next year rather than the autumn, which had been the prevailing best guess until recently.”

Ms Hewson noted in the immediate wake of Wednesday’s inflation data: “Looking at rate expectation this morning, there’s growing confidence cuts to the base rate could begin as early as March.”

Only time will tell, of course, what the MPC decides.

In the meantime, the great scepticism over the Bank of England’s tough talk on interest rates is most eye-catching.