BOE Hikes Rates 24 Hours After COVID Cases Hit Record

I’d say “better late than never,” but I’m not sure it’s applicable.

The BoE surprised markets Thursday with a 15bps rate hike, six weeks after wrong-footing traders by foregoing an opportunity to raise rates following what many took to be a clear-cut pre-announcement from Andrew Bailey who, during a virtual panel discussion in October, said the bank “will have to act” on inflation.

And they did. Act I mean. Only on a delay, and that’s potentially problematic because, while policymakers dithered, COVID mutated and the new, more transmissible variant found its way to the UK, where cases hit a new pandemic record this week (figure below).

The old record was 68,053. On Wednesday, the UK logged 78,610 cases. England’s chief medical officer, Chris Whitty, warned that “a lot” of pandemic records will be broken over the next few weeks. The UK is grappling with two epidemics, he warned. One driven by Omicron, the other by Delta.

It’s against that rather ominous backdrop that the BoE saw fit to deliver the policy tightening markets wanted in November. The vote was 8-1.

The wordy statement contained a lengthy attempt to reconcile rate hikes with the emergence of the Omicron variant. “The MPC’s remit is clear that the inflation target applies at all times, reflecting the primacy of price stability in the UK monetary policy framework,” the BOE said. The following additional color is worth highlighting:

Twelve-month CPI inflation rose from 3.1% in September to 5.1% in November, triggering the exchange of open letters between the Governor and the Chancellor of the Exchequer. Relative to the November Report projection, there has been significant upside news in core goods and, to a lesser extent, services price inflation. Bank staff expect inflation to remain around 5% through the majority of the winter period, and to peak at around 6% in April 2022, with that further increase accounted for predominantly by the lagged impact on utility bills of developments in wholesale gas prices. Indicators of cost and price pressures have remained at historically elevated levels recently, and contacts of the Bank’s Agents expect further price increases next year driven in large part by pay and energy costs. CPI inflation is still expected to fall back in the second half of next year.

As a reminder, the projected inflation path was revised higher last month. CPI was seen running around 4.5% through the winter, before retreating to 2% sometime in 2024 (figure below).

“The labor market is tight and has continued to tighten, and there are some signs of greater persistence in domestic cost and price pressures,” the MPC went on to say, adding that “although the Omicron variant is likely to weigh on near-term activity, its impact on medium-term inflationary pressures is unclear at this stage.”

Note that last week, Boris Johnson unveiled new measures to combat the spread of Omicron (and, quite possibly, to deflect from a scandal involving a leaked video of staffers mocking virus containment measures late last year).

The BoE discussed that (the new measures, not the scandal) and the potential read-through for growth. Their takeaway echoed the assessment of economists, analysts and other policymakers — namely, the variant’s spread and associated containment measures could weigh on growth, but the impact on inflation is ambiguous. Considering current price pressures, it’s better to err on the side of fighting inflation.

“The Omicron variant poses downside risks to activity in early 2022, although the balance of its effects on demand and supply, and hence on medium-term global inflationary pressures, is unclear,” the BoE said, adding that “global cost pressures have remained strong.”

Thursday’s move opened the door to discussions around balance sheet rundown. Markets were pricing just a 40% chance of a hike at the December meeting. If you like factoids and trivia, it’s worth noting that December hikes are exceptionally rare in the UK. In fact, it’s happened just once in nearly a half century, according to Bloomberg, and never since the bank gained independence in 1997. The same linked article noted that outside of the pandemic, December’s hike was also the first time officials moved at a non-Super Thursday meeting.

One way or another, the BoE is rolling the dice. “Inflation has twice come in above expectations since the Bank’s November forecasts, and that’s what seems to have swung it,” ING’s James Smith said. “Policymakers are calculating that in a year-or-so time, when rate decisions today will realistically filter through to the economy, the outlook will be little changed by Omicron.”

I suppose this goes without saying, but there’s no guarantee that hiking rates a few times over the next six months is going to bring down inflation. The irony is that once price pressures do abate, it’ll likely be difficult to decide what “caused” inflation to cool, because by that time, whatever factors were transitory will have faded away and rates will have increased concurrently.