- The Monetary Policy Committee (MPC) responded to another surprise inflation release, stronger-than-expected pay growth and a still-tight jobs market by going for a significant Bank Rate increase in its latest meeting. A 50bps rise lifted Bank Rate to 5%, the highest since September 2008.
- The fact that the MPC has now got ahead of market rate expectations could give it some leeway to skip what had been a widely-anticipated further rate increase when the committee meets next in August. A likely improvement in the inflation numbers over the next few months points in the same direction. And the EY ITEM Club thinks there’s good reason to suspect that monetary policy has now done enough heavy lifting.
- Forward-looking inflation developments have generally been positive. Pipeline price pressures and money growth have slowed significantly, inflation expectations among households and businesses have continued to fall and energy bills will fall by close to 20% next month. What’s more, the Bank of England's own estimate is that around two-thirds of the impact of past rises in interest rates is still to come.
- However, further rate rises can’t be ruled out. If the MPC’s concern about regaining ‘credibility’ causes policymakers to focus too little on what’s to come and too much on what’s already passed, monetary policy could be tightened unduly, pushing the economy into an unnecessarily substantial downturn.
Martin Beck, Chief Economic Advisor to the EY ITEM Club, says: “With inflation in both April and May well above the Bank of England’s expectations, core inflation no longer just sticky, but rising, pay growth still heated, and the jobs market tight, there was little doubt that the MPC would deliver another rise in Bank Rate in its June meeting. The question had been just how big the rise would be. With seven of the nine members voting to raise the policy rate by 50bps to 5%, Bank Rate is now at its highest level in almost 15 years. Two members voted to keep rates on hold.
“The fact that the MPC has now got ahead of market expectations (which had erred towards a 25bps rise) may give it leeway to skip what had been a widely-expected further rate rise when the committee meets next in August. With headline inflation expected to come down noticeably over the next few months, there could be further rationale for a pause. Last June saw petrol prices increase by over 9%, but pump prices are now falling, and July will see a material fall in household energy bills, reflecting the cut in the Ofgem price cap.
“On the other hand, it was noticeable that the MPC didn’t use June’s policy statement to push back against current market expectations that Bank Rate will continue to increase and peak at 6% early next year. The implication is that criticism of the Bank of England's credibility may have started to have an impact. After all, as concerning as the recent inflation numbers have been, they're now in the rear-view mirror. Forward-looking developments have generally been positive, with pipeline price pressures in April falling to the lowest in over two years, inflation expectations among households and firms continuing to fall, energy bills likely to decline by close to 20% next month, growth in the money supply slowing to a crawl from double-digit rates in 2021, and the stronger pound expected to bear down on import prices. Moreover, the Bank of England's own estimate is that around two-thirds of the effects of past rises in interest rates are still to come.
“These developments mean the EY ITEM Club still thinks that inflation should fall fast in the second half of 2023. And improving inflation prospects would ideally be the focus of a central bank setting a policy lever which doesn’t have its full impact for 18 months to two years into the future. However, the risk is that the MPC focuses on what has passed rather than what is to come. Setting policy reactively in response to incoming data risks the MPC raising interest rates too far and weakening the economy more than necessary.”
