A six-week interlude has taken at least some of the heat out of the debate over UK monetary policy in the run-up to Thursday’s interest rate decision.When the Bank of England’s nine rate-setters last met, in early November, they were under intense pressure to restore confidence in the UK’s economic management, after the market turmoil unleashed by the hastily reversed «mini» Budget, and to keep pace with aggressive tightening by the European Central Bank and US Federal Reserve.
It duly delivered a 0.75 percentage point interest rate increase — the biggest in more than 30 years — taking the benchmark rate to 3 per cent.
Now, gilt markets have calmed; the new prime minister Rishi Sunak has set fiscal policy on a more orthodox path; and there is a chance that both the Fed and ECB will slow the pace of rate rises this week.
So too could the BoE. The more hawkish members — such as Dave Ramsden and Jonathan Haskel — have argued that tightening should be front-loaded to bring inflation expectations under control and could vote for a bigger increase.
At the other extreme, Silvana Tenreyro has argued that the BoE has already done enough for inflation to fall below target, once the full effect of its recent tightening is felt, and Swati Dhingra has suggested that any further increase in borrowing costs will unnecessarily deepen and lengthen the impending recession.
Meanwhile, BoE governor Andrew Bailey has made it clear that «there will be more to do» to put inflation — which hit 11.1 per cent in October — on a sustainable path. He has been much less explicit about how fast, or how far, interest rates still need to rise, but when challenged by his predecessor, Mervyn King, acknowledged that the BoE viewed a recession as «part and parcel of the process needed to get inflation back to . . . 2 per cent on a sustainable basis».
Developments since the MPC last met offer food for thought for both doves and hawks on the committee.
There is some evidence to suggest that headline inflation has now peaked — with oil prices lower, sterling stronger and surveys showing that companies are becoming less confident of their ability to raise prices.
Two key data releases due early this week — the latest inflation reading and official figures on the state of the labour market — have the potential to swing the vote.
The single biggest worry for the BoE is that chronic labour shortages, caused in part by rising inactivity among older workers, will force employers to raise wages at a pace that would keep inflation stubbornly high, if they also try to maintain their margins by raising prices to compensate.
«We have to raise interest rates further than we otherwise would to counteract that,» Bailey told the House of Lords economics affairs committee last month — while noting early signs of hiring pressures easing.
Whether the MPC decides to front-load rate rises, or to act more cautiously, the crucial question is how far it will ultimately go.
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