BOE Condemns Putin, Hikes Rates, Adopts Dour Cadence

The first paragraph of the Bank of England’s March policy statement wasn’t about interest rates.

“The Bank of England condemns Russia’s unprovoked invasion and the suffering inflicted on Ukraine,” the world’s second-oldest central bank said Thursday. Then, they got personal. “The Bank’s Monetary Policy Committee supports this condemnation and welcomes these actions,” the statement read, referencing the UK’s sanctions, which include an embargo on Russian oil imports.

Although both the Fed and the ECB explicitly mentioned Ukraine in their own policy statements, the MPC’s direct chiding of Vladimir Putin was somewhat remarkable, and spoke to the notion that if we can conceptualize of the world as a community of reserve currency users, Russia is no longer welcome — at least until the country is under new management.

Having dispensed with what the Bank clearly believed was a necessary reproach, the MPC hiked rates for a third consecutive meeting. Bank Rate has returned to pre-pandemic levels (figure below).

Unlike the February meeting, when hawks were screaming, this hike was more cautious. “UK GDP in January was stronger than expected in the February Report,” the MPC said, adding that although “business confidence has held up and labor market activity data have remained robust,”  consumer confidence has deteriorated due to rising inflation and the read-through for household disposable incomes.

“That impact on real aggregate income is now likely to be materially larger than implied by the projections in the February Report, consistent with a weaker outlook for growth and employment, all else equal,” the statement went on to say.

Policymakers in the UK are walking the same tightrope as their counterparts in the US. Inflation is expected to remain very high, but the growth outlook has worsened, leaving monetary policy in a bind.

The MPC’s assessment of price pressures was dour. “Inflation is expected to increase further in coming months, to around 8% in Q2, and perhaps even higher later this year,” the bank said. Recall that the BoE revised its inflation forecasts sharply higher last month (figure below).

At the time, I wrote that “despite being spectacularly wrong so far, the BoE expects the public to trust a new set of forecasts which claim for the Committee the kind of supernatural prescience one would need in order to project a macro variable three years into the future.” Sure enough, the new statement represented an explicit nod to the prospect that inflation could rise well beyond the 7.25% April peak seen just six weeks ago.

Such an unwelcome development would be due to “global energy prices,” the MPC said, on the way to noting that “if sustained, the latest rise in energy futures prices means that Ofgem’s utility price caps could again be substantially higher when they are reset in October 2022… temporarily push[ing] CPI inflation around the end of this year above the level projected for April, which was previously expected to be the peak.”

So, inflation could hit 8% in Q2 and then rise back towards 8% again in Q4. How’s that for a challenging scenario?

Like its peers in Washington and Frankfurt, the BoE stuck to the notion that price pressures will eventually abate, due both to receding energy prices and demand destruction. And, yes, the MPC specifically mentioned the latter. “Inflation is expected to fall back materially as… the squeeze on real incomes and demand puts significant downward pressure on domestically generated inflation,” the statement said, before noting that monetary policy simply isn’t capable of addressing the fallout from certain kinds of exogenous tail events.

“The economy has recently been subject to a succession of very large shocks. Russia’s invasion of Ukraine is another such shock,” the bank lamented. The UK is a net importer of energy and tradable goods. That means sustained price spikes will undermine real incomes and thereby spending. “This is something monetary policy is unable to prevent,” the bank remarked, flatly.