- The case for keeping interest rates unchanged in the latest Monetary Policy Committee (MPC) meeting was a strong one, particularly in light of recent global banking sector challenges. Indeed, two members of the MPC voted for a pause. But a majority were swayed by continued inflation concerns and supported a 25bps rise in Bank Rate to 4.25%. However, the EY ITEM Club thinks this will be the last rise in rates in the current cycle.
- An upside surprise for inflation in February was probably decisive for the latest decision, with the committee likely concerned that not tightening further could affect its anti-inflation credibility. However, the rationale of another rate increase is not entirely obvious, given the significant tightening in monetary policy already in play and, notwithstanding February’s rise in inflation, growing disinflationary forces.
- The EY ITEM Club thinks the case to now pause on further rate rises will be enough to convince a majority on the MPC when it meets next in May. And the likely speed at which inflation falls back this year, combined with the risk of more financial fragilities emerging as a result of global monetary tightening, means the EY ITEM Club thinks there’s a good chance UK policymakers will be mulling rate cuts by the end of this year.
Martin Beck, chief economic advisor to the EY ITEM Club, says: “Until February’s higher than expected inflation figures were published earlier this week, the odds of the MPC raising Bank Rate further versus pushing the pause button had looked 50-50. But that upside surprise was probably key in convincing a majority on the committee to vote for a 25bps rise in the official interest rate to 4.25%. The MPC has for some time been concerned about the risk that domestically-generated inflation could prove persistent, concerns which remained evident in March’s policy statement and which were reinforced by the bounce-back in core inflation and services sector inflation in February.
“That said, two of the nine MPC members voted to keep Bank Rate on hold. These two members noted the substantial monetary tightening already in play since late 2021 (the biggest rise in rates over an equivalent period since 1989), the full effect of which has still to come through.
“While a majority on the MPC recognised the risk that recent developments in the global banking sector could lead to an excessive tightening in monetary conditions, they decided that a ‘wait-and-see’ approach was justified, with the Financial Policy Committee having judged that the capital strength and strong liquidity positions of UK banks should protect the UK from potential challenges abroad.
“The incoming data appears to be weakening the case for further rate rises. Rises in pipeline price pressures have continued to slow, wages growth has eased, according to both official statistics and the Bank of England’s own survey data, and energy prices have fallen further. As of 21 March, gas futures prices this year and next were around a third lower than the Bank of England was assuming as recently as February.
“The EY ITEM Club thinks this will be sufficient to sway a majority on the MPC to vote for no change by the time the committee meets next in May. By that point, headline inflation should have begun to meaningfully turn down and pipeline price pressures should look increasingly benign – to the extent that projected inflation could undershoot the 2% target by an even greater margin than the Bank of England expected in its last forecast. However, any further stresses that may emerge in the next few months in the financial system, following a global tightening of monetary policy, might necessitate a change of course by central banks in general. Bringing these factors together, the EY ITEM Club thinks today’s rate rise will prove the last in the current cycle and that there’s a good chance the MPC will be mulling rate cuts by the end of this year.”
