By raising Bank Rate by 50bps, the Bank of England’s Monetary Policy Committee (MPC) chose not to follow recent, more substantial, moves by the US Federal Reserve and European Central Bank. That said, the MPC vote saw an unusual three-way spilt, meaning the future path of interest rates has become less predictable.
The MPC’s decision to forgo a bigger rise in rates makes sense. The cap on energy bills will significantly reduce the prospective peak in inflation, as well as bearing down on households’ inflation expectations. And the price of oil, gas and many other commodities have continued to retreat from recent highs, which should contribute to inflation falling back significantly next year.
With tomorrow’s ‘mini-Budget’ likely to deliver some sizeable tax cuts, September’s increase in rates may not be the last rise this year though. The EY ITEM Club think this cycle of increasing rates is likely to come to an end around the turn of 2022-23, with Bank Rate peaking at 3-3.25%.
Meanwhile, the Bank of England said it will start to sell gilts. With this move well-signalled in advance and planned sales relatively small in volume, any market response is expected to be modest. However, with gilt issuance set to expand significantly to finance energy price support and forthcoming tax cuts, ‘quantitative tightening’ increases the challenge of finding enough buyers for government debt.
Martin Beck, chief economic advisor to the EY ITEM Club, says: “Following the Government’s announcement of a generous fiscal support package to households and businesses to cap energy bills – alongside recent sizeable rises in interest rates by the US Federal Reserve and the European Central Bank, and the weakness of sterling – the MPC’s decision to raise Bank Rate by 50bps, rather than a steeper 75bps, may have come as a surprise to some. Although three members voted for 75bps, five favoured 50bps, while one member supported a smaller 25bps increase.
“There were good reasons for the committee’s relatively guarded approach. For one, the new cap on household energy bills means the Bank of England now expects inflation to peak at just under 11% in October and, by early 2023, be 5ppts lower than if bills had risen in line with the Ofgem price cap and the behaviour of wholesale gas prices. In the MPC’s view, this reduces the risk of externally-generated inflation leading to more persistent domestic price and wage pressures.
“Meanwhile, the price of oil, gas and other commodities have continued to retreat from recent highs, in the case of gas, substantially so, while other pressures on businesses’ bottom lines, such as shipping costs, have also come down significantly. The Bank of England also announced that it will proceed with plans to begin selling gilts, and with this move well-signalled in advance and planned sales relatively small in volume, any market response should be modest. However, this will tighten monetary conditions relative to the counter-factual.
“Today’s rise in Bank Rate may not be the last we see in 2022. The MPC remains concerned about the tightness of the labour market and the implications for wage pressures, and it noted that tomorrow’s ‘mini-Budget’ was likely to have material implications for the economic outlook. As fiscal policy is likely to be loosened further via tax cuts, all things being equal it appears that tighter monetary policy would be the consequence. But the extent of this offset will depend on the Government’s measures to boost the economy’s potential contained in the forthcoming Growth Plan, and how convincing they are.
“As things stand the EY ITEM Club thinks the MPC will raise rates again in its next meetings in November and December, although the divisions seen in September’s vote make predicting the size of those increases tricky. But as evidence of disinflationary pressures build, the cycle of increasing rates is likely to come to an end around the turn of 2022/2023, with Bank Rate forecast to peak at 3-3.25%.”