The Bank of England’s rush job on inflation
The Bank of England (BoE) has been turning hawkish amid rapidly rising inflation. A chorus of Monetary Policy Committee members has signalled that rate hikes are approaching, driven by a desire to nip in the bud the risk of second-round effects. We are updating our BoE scenario: we now predict a technical rate hike of 15bps in the next two months (most likely in November), followed by another 25bps hike in Q1 2022 and then a pause.
Raising rates would break our macro ‘model’ for the Bank of England. This assumed the BoE would not go solo before the Federal Reserve (which we do not see pushing up rates before 2023). In this model, BoE interest rates were seen as mostly a consequence of Federal Reserve and European Central Bank policy.
A BoE rate hike at this point in time looks to us a risky move given a rapidly deteriorating domestic economic outlook and a growing energy crisis, as well as the deteriorating EU-UK relationship over Northern Ireland’s trade status. Another downside risk to UK growth is the direction of fiscal policy. In 2021, the government announced first a rise in corporate taxes and then a rise in national insurance and dividend taxes, even though government borrowing costs are still cheap and the UK’s finances are in no worse a state than elsewhere. The danger is that rising taxes hurt business sentiment.
Furthermore, there is limited data available about the effects of the end of the jobs furlough scheme in September; the BoE is very much groping in the dark at this stage. We are keeping our 2021 GDP growth forecast for the UK at 6.5% while mindful that the recovery has, at best, plateaued. But macro risks are pointing downwards. We think the bumpy road the UK economy is facing in the coming months will cause the Bank of England to halt rate hikes in Q2 2022.
Our UK consumer inflation forecast of 2.7% in 2022 is under review for upgrade due to spiralling energy prices. But we struggle to see second-round effects materialising and inflation becoming more persistent in 2023 --although “bad inflation” caused by post-Brexit trade frictions could mean it stays higher than in other peer countries in the longer run.