- As expected, the Monetary Policy Committee (MPC) voted to raise Bank Rate to 0.5% from 0.25%. Following December’s rise, this was the first back-to-back increase in rates since 2004. Four members of the committee voted for an even steeper rise, to 0.75%.
- The MPC now thinks inflation will peak at just over 7%, even allowing for the intervention announced by the Government to hold down rises in energy bills. And it downgraded its forecast for GDP growth this year to 3.75% from 5% previously.
- The MPC also predicted that higher energy prices would materially affect growth and raise unemployment. Along with the committee’s forecast that inflation will fall below the 2% target in the medium term, this leads the EY ITEM Club to expect no more than two further increases this year, leaving Bank Rate at 1% at the end of 2022.
- The Bank of England will now stop reinvesting gilts bought under the quantitative easing programme. ‘Quantitative tightening’ will do some of the heavy lifting in removing monetary stimulus, which is another reason why the EY ITEM Club expects future rate rises to be more gradual than financial markets expect.
Martin Beck, chief economic advisor to the EY ITEM Club, says:
“The MPC’s decision to raise Bank Rate to 0.5% from 0.25% is the first back-to-back increase in rates since 2004 and takes monetary policy further along the path to exiting pandemic-era stimulus. February’s vote was far more split than in the last meeting in December, with a 5-4 margin in favour of the decision. But surprisingly, all those in the minority favoured a steeper increase in Bank Rate, to 0.75%.
“The committee now expects inflation to peak at just over 7% in the spring, up from around 5% in the last set of forecasts in November. This is allowing for the measures announced by the Government earlier today to offset some of the rise in energy bills due in April. The MPC remains concerned about potential second-round effects from rising inflation, including higher wage growth and inflation expectations among the public becoming detached from the Bank of England’s target.
“The MPC’s concerns about inflation took precedence over a downgrade to its forecast for GDP growth this year from 5% to only 3.75%. The negative effect of higher energy prices on consumer spending is also expected to push unemployment up to 5% over the next few years, while real post-tax labour income is expected to experience the biggest fall this year since records began in 1990. With the recovery aided by an easing of COVID-19 concerns and strong household and corporate balance sheets, the EY ITEM Club thinks the MPC’s growth forecast is too pessimistic. But the committee’s gloomy outlook for growth should rein back the risk of interest rates rising too far, too fast, as does its prediction that inflation will fall below the 2% target in two to three years.
“That ‘quantitative tightening’ will now do some of the heavy lifting in removing monetary stimulus is another reason to think that rates increases will be gradual. The MPC said last summer that it will stop reinvesting gilts bought under the quantitative easing programme once Bank Rate reaches 0.5%. That threshold has now been met and the committee announced that it will start following its guidance from this month onwards. This reinforces the EY ITEM Club’s expectation that the MPC will deliver no more than two further rate rises this year, leaving Bank Rate at 1% by the end of 2022.”