Crisis-Battered Bank Of England Stares Into Dark Abyss

The UK economy shrank in April from the prior month, data out Monday showed. It was the second consecutive monthly contraction. Economists expected a slight gain.

The data came days ahead of the Bank of England’s June gathering, at which policymakers will surely hike rates for a fifth consecutive meeting.

The GDP figures are distorted by the impact of health spending, and particularly the end of free COVID testing. Mitigating factors aside, April marked the first time all main sectors contributed negatively to a monthly GDP estimate since January of 2021. The figure (below) shows the breakdown.

“Just as health-related spending gave the level of GDP an artificial boost last year, helping the economy appear to recover to pre-virus levels more quickly than it actually had, these categories are now making the picture look superficially worse,” ING’s James Smith wrote Monday.

Even by the very “high” standards of 2022, a year defined by tough times, the UK is having a rough go of things. Political theater and the resumption of Brexit-related brinksmanship come atop the worst cost of living crisis in modern history.

The BoE’s May meeting was a debacle, and public faith in the institutional has crumbled. In the latest polling, the bank’s net approval rating turned negative for the first time since it gained independence (figure below).

As the BoE helpfully explains, “respondents [are] asked to assess the way the Bank of England is ‘doing its job to set interest rates to control inflation.'” The “net satisfaction balance” represents the proportion of respondents satisfied minus the proportion dissatisfied. In May’s survey, that figure was -3%, the culmination of a yearlong plunge.

It’s hardly surprising that opinions on the bank’s inflation-fighting efforts have soured. After all, inflation is 9% and the bank’s forecasting track record is laughable (figure below) even considering the impossibility of predicting Russia’s Ukraine misadventure.

The last projections showed the BoE expects inflation to exceed 10% on average during the fourth quarter.

Notwithstanding the mathematical reality of the distortions that weighed on the headline monthly GDP reading released Monday, it’d be ludicrous to call the negative print a positive development. But if there was a silver lining, it’d be the extent to which it relieved some pressure on the beleaguered MPC to hike by 50bps this week.

Recall that last month’s decision betrayed a divided panel. Again. The vote was 6-3, with the dissenters favoring a 50bps move.

One way or another, rates will almost surely rise to a 13-year high. A 25bps move would put Bank Rate above 1% for the first time since the financial crisis (figure above).

Failing to hike could exacerbate inflation at a time when it now costs £100 on average for UK drivers to fill up their cars.

The Ofgem adjustments are obviously a key part of the inflation equation. “Assuming employment remains solid, and factoring in the recent government support package, we think a consumer-led recession may be avoided, though ultimately a lot depends on whether we get another leg higher in wholesale energy prices this autumn,” ING’s Smith went on to say.

“In contrast with previous months, April inflation did not surprise to the upside, which against a backdrop of inflation forecasts peaking in October, provides the BoE with some headroom before it could be accused of underestimating inflation dynamics again,” Barclays ventured, calling the stakes for this week’s meeting “fairly low.”

I’m not sure UK households would agree with that assessment. As Bloomberg’s David Goodman wrote over the weekend, “post-pandemic Britain [is] on course to underperform every other major leading economy next year [and] consumer confidence is already below levels seen in any economic downturn since at least the 1970s, even before the full effects of the fastest inflation in decades kicks in.”

Like the Fed and the ECB, the BoE has little choice but to keep hiking rates into the burgeoning slowdown. Somehow, I doubt that’s going to help the institution’s approval rating. Nobody wants to hear that the solution to high inflation is a recession.

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