Press release

5 Aug 2021 London, GB

Some dissent on the MPC and inklings of tighter policy ahead – EY ITEM Club comments

The MPC revised up its inflation forecast further, with the CPI measure now expected to reach 4% by the end of this year. A majority on the committee stuck to the view that higher inflation will be transitory. But concerns that the UK faces a more persistent inflation issue caused one member to break ranks and vote to end asset purchases immediately

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  • The MPC revised up its inflation forecast further, with the CPI measure now expected to reach 4% by the end of this year. A majority on the committee stuck to the view that higher inflation will be transitory. But concerns that the UK faces a more persistent inflation issue caused one member to break ranks and vote to end asset purchases immediately.
  • There were also some indications that the committee may have moved a bit closer to having a majority in favour of policy tightening. Several MPC members judged that the necessary conditions for tightening had been met – albeit conceding that those conditions, while necessary, were not sufficient. GDP growth in 2022 and 2023 was revised up. And with unchanged interest rates, the MPC expects inflation to continue exceeding 2% over the medium-term, the time frame relevant for monetary policy, and by a greater margin than forecast in May.
  • However, the case for a ‘wait-and-see’ approach remains strong. COVID-19 uncertainty has not gone away and time is needed to assess the persistence, or otherwise, of higher inflation and how the economy copes with the end of the furlough scheme and other government support in the autumn. The EY ITEM Club continues to expect interest rates to start rising in late 2022, when the economic impact of the pandemic will hopefully have faded and the economy is returning to its pre-pandemic trajectory.

Martin Beck, senior economic advisor to the EY ITEM Club, says:

August’s MPC meeting delivered an 8-0 vote in favour of keeping Bank Rate unchanged. But the vote on asset purchases revealed some dissent. One member voted to cut the target stock of asset purchases from £895bn to £850bn, effectively ending Quantitative Easing immediately.

“The dissenting member had previously expressed concerns that higher inflation could prove long-lasting, so this hawkish shift was well signalled. The willingness to break ranks can only have been aided by the MPC’s latest forecasts. CPI inflation is now expected to peak at 4% later this year, up from a peak of 2.5% in the last set of forecasts in May. And the MPC stuck to its above-consensus view on GDP growth. Granted, May’s weaker than expected rise in GDP and concerns over the impact of higher numbers of COVID-19 infections resulted in a downgrade to predicted growth in Q2 and Q3. However, stronger growth towards the end of this year mean the economy is still expected to return to its pre-pandemic size by the end of 2021. The committee kept forecast growth in 2021 at 7.25% and raised growth next year from 5.75% to 6% and from 1.2% to 1.5% in 2023. The MPC has also become more optimistic on the jobs front: the forecast unemployment rate in Q3 2021 was cut to 4.7% from 5.4% previously and the end of the furlough scheme in September is now expected to prompt no meaningful rise in unemployment.

“Most MPC members remain content with the view that higher inflation will be a temporary issue. However, there were some inklings that a tightening of monetary policy may have moved closer. Several on the committee judged that the conditions previously considered necessary before policy could be tightened had been met, albeit conceding that those conditions, while necessary, were not sufficient. Assuming the Bank Rate remained unchanged at the current 0.1%, the committee now expects CPI inflation to remain above 2% in the medium-term, the metric relevant to policy decisions, and by a bigger margin than expected in May. For example, CPI inflation is expected to be 2.4% in mid-2023, compared to 2.2% forecast in May. And a more pronounced period of above-target inflation was despite the MPC taking a more optimistic view of the pandemic’s long-run scarring effect on the economy. The anticipated permanent consequences for the economy from the pandemic was revised down to 1% from 1.25% previously, implying that the economy can run hotter for longer before inflation takes off.

“But, despite hawkish elements to the MPC’s latest policy statement, the case for a ‘wait-and-see’ approach remains strong, both in assessing just how temporary higher inflation proves to be and the consequences of the end of the furlough scheme and other government support measures in the autumn. Given this, the EY ITEM Club continues to expect no rise in Bank Rate until late 2022, when the economic impact of the pandemic will hopefully have faded and the economy is returning to its pre-pandemic trajectory.

“Finally, the MPC provided new guidance on the future of the Bank of England’s balance sheet. The Bank will begin to the reduce the size of its balance sheet, which has been enlarged via successive rounds of Quantitative Easing, earlier than previously planned. The committee will now consider actively running down asset purchases when the Bank Rate rises to 1%, compared to a threshold of 1.5% previously. And it will consider stopping the reinvestment of maturing gilts in its portfolio when Bank Rate reaches 0.5%. But when the time does come to reverse Quantitative Easing, as long as financial markets are functioning normally and investors have a clear idea of the future path of interest rates, the EY ITEM Club concurs with the MPC in judging that the consequences for monetary conditions and the economy should be small.”