The Bank of England raised rates for a seventh consecutive meeting on Thursday, escalating a desperate inflation fight and likely condemning the UK to an even deeper recession.
Although large by recent BoE standards, the 50bps hike may underwhelm some observers and market participants. 75bps was a close call. The vote was split, to put it nicely. Five members voted for the 50bps move, three for a 75bps hike and one for a 25bps increment. As far as I can tell, there hasn’t been a three-way split since the GFC.
It was the second straight half-point increase. August’s 50bps hike was the largest in more than a quarter century. Bank Rate is now the highest since December of 2008 (figure below).
As is the case with all developed market central banks in 2022, the BoE is attempting a high-wire act. By the bank’s own forecasts, the UK economy is destined for a prolonged recession, and rate hikes plainly won’t help. Further, it’s not obvious that higher rates will deliver price stability when the proximate cause of runaway price growth is a war and an attendant shock to energy and food costs.
Inflation receded in the UK last month thanks to falling petrol prices, but at 9.9%, headline CPI is still quintuple the BoE’s target. In August, food and non-alcoholic beverage prices jumped more than 13% on a YoY basis, the 13th monthly gain in a row. Although petrol prices dropped smartly, the annual rate of motor fuels inflation was still 32%, less onerous than July’s 44%, but still entirely too high.
Liz Truss’s plan to cap energy prices has removed the tail risk of 20% inflation in the UK, but it could forestall demand destruction and risks embedding price pressures in the economy for longer. In that case, the BoE would be doomed to an indefinite inflation fight.
“Given the Energy Price Guarantee, the peak in measured CPI inflation is now likely to be lower than projected in the August Report, at just under 11% in October,” the bank said Thursday. “Nevertheless, energy bills will still go up and, combined with the indirect effects of higher energy costs, inflation is expected to remain above 10% over the following few months, before starting to fall back.”
The figure (above) gives you a sense of just how indeterminate the situation really is. Forecasting macro outcomes is a mostly fruitless endeavor even in the best of times — a fool’s errand born of PhD hubris. Over the past two years, though, it was rendered entirely pointless in the UK.
In the September statement, the MPC alluded to the possibility that government support measures, while helpful for preventing an EM-style inflation spiral, will support demand with implications for monetary policy.
“The [Energy Price] Guarantee is likely to limit significantly further increases in CPI inflation, and reduce its volatility, while supporting aggregate private demand relative to the Committee’s August projections,” the bank said. “An additional Growth Plan announcement is scheduled to take place shortly after this MPC meeting, which is expected to provide further fiscal support, and is likely to contain news that is material for the economic outlook.” The situation, as they say, is fluid. Additional details about the energy relief plan, as well as tax cuts, will be unveiled on Friday. The plan is expected to cost around £200 billion.
Again, the risk is that rescuing households and businesses now means the necessary economic adjustment takes longer to play out. I won’t pretend to be a proponent of “letting it burn,” so to speak, but I’d be remiss not to at least acknowledge the risk that massive subsidies could exacerbate and extend the demand-supply imbalance driving up inflation.
Crucially, the BoE voted unanimously to reduce its gilt holdings by £80 billion over the next twelve months. That, at a time when yields are rising and the Truss government is embarking on expensive fiscal stimulus. Spending on the energy plan will be probably be financed with new gilts, and there’s palpable concern about Treasury’s “uncapped liability” given the vagaries of wholesale gas prices. The private sector will need to absorb both the new issuance and the gilts sold by the BoE.
Commenting further on the energy guarantee, the BoE said that although it “reduces inflation in the near term, it also means that household spending is likely to be less weak than projected over the first two years of the forecast period.” “All else equal, and relative to that forecast, this would add to inflationary pressures in the medium term,” policymakers gingerly remarked.