- Subject to no major downside surprise in May’s inflation numbers, the EY ITEM Club thinks the Monetary Policy Committee’s (MPC) concerns about inflation persistence will prompt it to raise Bank Rate by 25 basis points to 4.75% later this week. However, the ingredients for an improvement in the inflation outlook means current market expectations of rates peaking at close to 6%, and all the economic effects that would entail, look too pessimistic.
- A still-tight jobs market and recent upside surprises in both services inflation and private sector pay growth probably satisfy the MPC’s criteria for evidence of ‘persistent’ inflationary pressure which would lead to another rate rise.
- But not all recent inflation developments have been adverse. Producer price inflation has continued to fall, as have households’ and businesses’ inflation expectations, while growth in the money supply has slowed to a fraction of 2021’s peak. While wholesale energy prices have been volatile, the general direction has remained downward. And an unexpectedly large fall in inflation in the eurozone suggests that there's nothing inevitable about the current bout of strong price pressures proving sticky.
- As a result, the EY ITEM Club thinks current market expectations for five additional rate rises beyond June would represent too much monetary tightening and that the MPC may push back against predictions of such significant measures in its next policy statement. However, much will depend on May’s inflation data, which is published the day before the MPC’s policy announcement.
Martin Beck, Chief Economic Advisor to the EY ITEM Club, says: “The fact that the MPC was clear in May’s meeting on the criteria it would use to judge whether further rate rises were necessary makes predicting the outcome of this week’s meeting less of a challenge than normal. Evidence of more persistent pressures in services inflation and pay growth was set out as being key. With growth in both of those measures coming in above the Bank of England’s expectations in the latest data, it’s highly likely that a majority of the committee will support another 25bps increase in Bank Rate in June’s meeting. This would take the policy rate to 4.75%, the highest since September 2008.
“However, the fact that May’s inflation data will be published the day before the MPC’s decision is announced adds an element of complication. There’s no obvious reason to expect inflation to have surprised to the downside in May. However, inflation in the eurozone undershooting consensus expectations last month suggests there's nothing inevitable about the current bout of strong price pressures proving sticky. Furthermore, not all developments since the MPC’s last meeting suggest that the UK will remain slow compared to other markets in terms of inflation falling back.
“Recent surveys from the Bank of England and Citi/YouGov show inflation expectations among the public continuing to decline. The Bank of England’s own Decision Maker Panel survey of businesses also suggested pay and price expectations have eased in recent months. And there remain good reasons to think the fall in inflation since last autumn will gather pace, as powerful base effects kick in, a slowdown in pipeline price pressures feeds through to consumer prices, household energy bills fall on the back of a significant decline in wholesale prices, and the consequences of a marked slowdown in monetary growth leaves its mark.
“A potential challenge to this benign picture is a continuation of strong growth in pay. But whether wage growth is a coincident or causal element of the inflationary process is open to debate. And a combination of declining inflation expectations and a boost to the supply of workers from falling inactivity and record high net migration is likely to push down on pay growth. These factors mean the EY ITEM Club thinks that current market expectations for Bank Rate to peak at around 6% are too high, and that taking rates to such a level would represent excessive monetary tightening. Uncertainty over where short-term inflation data is headed makes predicting the likely peak difficult. But as things stand, the EY ITEM Club doubts rates will rise above 5%.”