- The Bank of England’s Monetary Policy Committee (MPC) increased Bank Rate again today, meeting expectations of a 50bps rise to 4%. It also presented a significantly less gloomy forecast than three months prior, if still erring on the pessimistic side in the EY ITEM Club’s view, anticipating inflation falling faster in 2023 and a much milder recession. The EY ITEM Club thinks the case for further rate rises has faded and that today’s increase could prove the last of the current cycle.
- Persistently strong pay growth and high services sector inflation gave the MPC justification for the latest rise in borrowing costs. The economy has also been less weak than expected, and projected GDP was revised up off the back of lower market interest rate expectations and a fall in energy prices.
- The Bank of England’s new forecast showed inflation falling well below the 2% target during 2024, were rates to be held at 4%. Given the MPC’s continued concerns about upside risks to inflation, this isn’t certain to rule out further rises. However, the language of February’s policy statement was noticeably more dovish than that of recent meetings.
- In the EY ITEM Club’s view, recent developments in demand, supply and monetary conditions mean it’s very hard to make a case for further monetary tightening, and there’s a good chance the Bank of England will be mulling cuts in Bank Rate by the end of this year.
Martin Beck, chief economic advisor to the EY ITEM Club, says: “As widely expected, the MPC voted to raise Bank Rate by 50bps to 4% in February’s meeting. As in the last meeting in December, two members favoured keeping rates unchanged. However, unlike in December, no member supported a bigger-than-consensus rise.
“The majority in favour of tighter policy cited persistently strong pay growth, a tight jobs market and stubbornly high services sector inflation as making the case for higher rates. The fact that that the Bank of England now thinks the economy will be less weak than expected previously offers another justification. The two-year long recession, 3% peak-to-trough contraction in GDP, and the doubling of unemployment forecast in November have now become a projected downturn lasting five quarters, with output falling 1% in total, and a much more modest increase in joblessness. The improvement mainly reflects a fall in market interest rate expectations (which the Bank of England forecast is conditioned on) and lower energy prices.
“In the EY ITEM Club’s view, the Bank of England forecast remains too pessimistic. The economy is still expected to shrink in 2024 on a calendar-year basis, despite pressure from high inflation fading. Households being expected to continue saving substantially more than pre-COVID-19 norms is one reason behind this. But this may be a questionable assumption given the significant savings accumulated by households during the pandemic and the likelihood that the mood-music around the economy will steadily improve, boosting consumers’ appetite to save less and spend more.
“Cheaper energy contributes to inflation falling faster this year (to 3.8% by Q4 2023) than expected three months ago. Furthermore, the Bank of England’s forecast, assuming Bank Rate remains at its new 4% level, shows inflation falling to less than 1% in Q2 2024 and running at only 1.5% and 0.5% at the end of 2024 and 2025 respectively – all well below the Bank of England’s 2% target.
“Granted, the MPC still thinks that “the risks to inflation are skewed significantly to the upside”. However, the committee dropped language used in previous policy statements that it could respond “forcefully” in future, instead saying that further rate rises would only be needed if there were new signs that inflation was going to prove persistent. Moreover, previous language that a "majority" of the Committee judged that further increases in Bank Rate may be required for a sustainable return of inflation to target was also absent, and there was no pushback against investors’ expectations that rates will be decreased later this year.
“The EY ITEM Club thinks the peak in Bank Rate has now been reached, at least for the current rate-rise cycle. The case for tightening policy further is unconvincing on several counts. A weak economy points to demand-pull pressures on inflation easing. On the supply side, recent declines in the price of energy, other commodities and shipping costs will steadily feed through to downward pressure on consumer prices, while other supply chain frictions should ease. Growth in the money supply has also fallen back substantially, a development which will be exacerbated by the Bank of England’s policy of quantitative tightening. With the risks pointing to inflation falling faster than expected and significantly undershooting the 2% target, the EY ITEM Club sticks with the expectation that the MPC will be mulling rate cuts by the end of this year.”