Bank of England inflation problem becomes embarrassing

IInflation is increasingly difficult to ignore.

From central bankers to ordinary consumers grimacing over their energy bills, the rate at which prices are rising has become a pressing concern. Investors are also worried.

Financial markets are betting that the Bank of England’s key interest rate could reach 1% by the end of 2022, the highest rate in more than a decade, starting with a slight hike of 0, 15 percentage point next December. But this comes against an uncertain global economic backdrop and a seemingly faltering UK recovery, limited by shortages of materials and labor.

This puts the Bank of England in a difficult position. On November 4, interest rate-setting makers on Threadneedle Street face a problem they’ve weighed in for months – that rising inflation is a pandemic pest in the near term, resulting from the stopping and restarting the economy as well as jamming global supply chains, or a lingering problem that needs to be contained with rising interest rates.

If the committee of rate setters raises the key interest rate, that means the central bank must get ahead of its international peers, ahead of the US Federal Reserve and the European Central Bank.

The Bank of England’s own forecast is that inflation will hit over 4 percent by the end of this year, potentially exceeding the underlying growth in real average wages calculated by the Office for National Statistics. US figures, released on Wednesday, showed price growth in the world’s largest economy remains high.

Andrew Bailey, Governor of the Bank of England, has changed his tone on the matter. In July, he said it was “important not to overreact to temporarily strong growth and inflation.” Last week he said: “We have some very big and unwanted price changes” that could prove to be “very damaging” if they become “entrenched” in the economy, longer term.

Interest rate hikes are painful for someone who might have a mortgage or debt, but they can be good news for savers and they move vast waves of money into the financial markets.

But while investor bets indicate a hike will come soon, before the end of the year, some economists believe it would be a misstep. It has been difficult to determine exactly what the central bank is leaning towards.

Investors are obsessed with examining every word central bankers say, whether written or spoken. Many are now using artificial intelligence to try and create sets of language habits to figure out what exactly a given sentence might indicate. The Bank of England, like other central banks, knows this and therefore tries to offer calm and clear signals to the markets, to avoid panic or disruption.

Yet that sensitive chain of communication got a little tangled around paragraph 65 of the Bank of England’s latest minutes, according to John Wraith, head of rate strategy at Swiss bank UBS.

He said: “All members of this group agreed that any future initial tightening of monetary policy should be implemented by an increase in the bank rate, even if such tightening becomes appropriate before the end of the existing purchasing program. UK government bond assets. “

The mentioned bond buying effort, also known as quantitative easing (QE), is expected to continue until mid-December. Investors deduced that this was therefore a signal for a rate hike as early as November, based on paragraph 65. But Wraith doesn’t think it’s that simple.

“My interpretation is that they don’t say ‘hint, we think we could increase rates any minute now,’” Mr. Wraith said. Rather, it was a signal that if pricing officials fear inflation will get out of hand, they will raise interest rates first. It’s not a deadline, Wraith explains.

This is a view shared by Neil Shearing, group chief economist at Capital Economics. He doesn’t think a hike this year is a “done deal,” but that the key rate is likely to rise before May 2022.

Still, Goldman Sachs analysts said Friday that a hike at the November meeting was “more likely” than in December, and that they said rates would rise this year.

Several forces are currently fueling inflation in the UK, many of which are external and internal. The UK is a country dependent on imports, from meeting its energy and food needs to its dependence on foreign investment to finance its current account deficit. And as world prices for a multitude of commodities have risen, the value of the pound has weakened. This led to more imported inflation.

But if the Bank of England tries to quell this price pressure too soon, it could backfire.

“I think raising the rate now would be partly in the hope, or in order, to strengthen the pound,” Mr Wraith said. But that could be the wrong signal to send to investors as other evidence suggests the economic recovery is still fragile. “The danger is that the market will say, ‘Well, you left here too early.’ ”

While expectations of high interest rates normally increase the value of a currency, recent expectations of a rate hike have had the opposite effect. Data from the Commodity Futures Trading Commission showing bets against the pound indicate that traders believe a rise would backfire, as Mr Wraith suggests. Rather than strengthening the pound, they argue, high interest rates could weaken it further, slowing economic growth.

There are also labor mismatches in the economy to tackle. The leave has ended and record-breaking job vacancies have been posted, but some workers appear to be pulling out of the workforce altogether, while other released workers do not necessarily match the skills employers need.

This mismatch effect means that while the image of the labor market may appear positive, it is not what economists call “strained”. This means that what appears to be a traditional source of inflation – a high employment rate, which can push up wages when employer demand reaches the limit of labor supply – might just be an effect. in some sectors, rather than the economy as a whole.

A cost-of-living crisis is also looming, in which many benefit claimants have jobs, but are underemployed and with too few hours or too few paid to meet their needs.

“The economy has been warped by the pandemic,” said Ian Mulheirn, chief economist at the Tony Blair Institute for Global Change. “For now, you should still consider the inflationary effect to be temporary.”

But being temporary doesn’t mean price growth will slow down quickly. “One sobering thing is that these pressures could last for some time,” says Mulheirn. Inflation could remain high, well above the central bank’s 2% target, until next year.

That’s part of why, he says, Governor Bailey is starting to speak harshly about price pressures in an attempt to manage expectations as inflation turns out to be stiffer than expected.

“There is a bonus in being vigilant at this time. The hope is maybe that by being vigilant you don’t have to act as quickly as if you looked relaxed. I suspect they are trying to send a message, ”Mulheirn said. But the costs of “acting too soon” and giving in to pressure to raise rates are “far less” than the risk of inaction.

Some around the table who will be deciding on interest rates in a few weeks believe that a hike this year would be too severe for the economy. But there is no doubt that inflation has proven to be more persistent than first forecast, and there is no doubt among economists that the UK still has a long way to go in its post-pandemic recovery. .

“As the governor himself said, there are ‘difficult projects’ ahead of us. It strikes me as undeniable, ”says Wraith.

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Nancy Owens

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