- The Monetary Policy Committee’s 8-1 decision to raise Bank Rate from 0.50% to 0.75% was the third increase in a row and takes borrowing costs back to their level immediately before COVID-19.
- But unlike February, no member voted for a larger 50bps rise. With the economic outlook uncertain, the EY ITEM Club thinks the Committee will now put more weight on supporting activity above trying to rein back price rises driven by global forces, implying a slower pace of rate increases going forward.
- The MPC expects inflation to rise to 8% in Q2, up from forecast of 7.25%, and potentially increase even higher later this year. The Committee remains concerned about ‘second-round’ effects from rising inflation to domestic wage- and price-setting. But the Committee acknowledged that the impact on supply affecting the UK economy will have a disinflationary effect by reducing consumer incomes and demand.
- Given the weaker economic outlook and geopolitical uncertainty, the EY ITEM Club thinks the MPC will tread cautiously in raising interest rates further. And the recent volatility in energy prices strengthens the case for a wait-and-see approach. The EY ITEM Club anticipates no more than one or two further rate rises over the rest of 2022.
Martin Beck, chief economic advisor to the EY ITEM Club, says:
“Today’s decision by the MPC to raise Bank Rate to 0.75% from 0.50% followed increases in the previous two meetings, a series of back-to-back rate rises not seen since 1997. With Bank Rate now back to its immediate pre-COVID-19 level, on that measure, monetary policy has exited ‘emergency’ settings, consistent with GDP now sitting above where it was pre-pandemic.
“Following recent rises in energy and other commodity prices, the MPC expects inflation to reach 8% in Q2 and potentially higher later this year, depending on what happens to the energy price cap in October. The Committee continues to be concerned about ‘second round effects’ – rising inflation becoming embedded in worker’s wage demands and companies’ price-setting, causing a wage-price spiral.
“However, the MPC also acknowledged that the impact of supply affecting the UK economy will depress incomes and spending. This may have contributed to today’s decision revealing an arguably more dovish committee. In February, four members voted for a 50bps rise in rates. But there was no support for such a move this month. And while February’s vote to raise the rate was unanimous, March’s meeting saw one member support keeping policy on hold. Moreover, there was no change in the policy statement’s previous wording that any further tightening would be “modest”.
“Higher borrowing costs will exacerbate the mounting cost of living pressures faced by households from rising energy prices, the rising price of other essentials and forthcoming tax increases. The merits of the MPC’s decision today will be subject to debate, but to the extent that it may prove to be a policy ‘mistake’, the mistake should be a small one, reflecting the falling share of households with a mortgage and the dominance of fixed-rate mortgage debt. The Bank of England’s own estimate is that a 0.25ppt rise in rates reduces GDP by less than 0.2%.
“The impact of higher energy and commodity prices on the UK economy means the MPC will have to tread carefully in tightening policy further. There is nothing UK monetary policy can do to increase the supply of gas and other commodities. And changes in interest rates take 12-18 months to have their peak effect. So increases in rates now and in the near-future may kick in at a point when base effects and stable, or falling, energy prices mean inflation has fallen back significantly. Moreover, the MPC will be mindful of past episodes where central banks have over-reacted to supply shocks by raising interest rates too quickly and contributed to a recession.
“If, by the time of the MPC’s next policy meeting in May, more persistent inflation looks likely, another rise in Bank Rate would be a strong possibility. But if economic activity takes a serious turn and uncertainty remains elevated, the case for the MPC to hold fire and pause policy tightening would be strong. Overall, the EY ITEM Club anticipates no more than one or two further rate rises over the rest of 2022, leaving Bank Rate at 1%-1.25% at the end of this year.”