- Still-strong pay growth and upside risks to inflation were enough in the MPC’s eyes to justify another rise in Bank Rate in its latest meeting. August’s policy statement wasn’t short of hawkish language either. But the committee reverted to a more ‘standard’ 25 basis points (bps) rise rather than repeating June’s 50bps increase. Moreover, reassuring developments in most leading indicators of inflation mean the EY ITEM Club thinks the MPC will struggle to justify more than one more rate rise.
- The MPC’s continued concerns about the ‘second-round’ effects of strong pay growth feeding through to high inflation, plus potential internal worries around criticisms of the Bank of England, mean the latest rise in interest rates was virtually a given. Indeed, a change in the MPC’s personnel saw the majority in favour of tighter policy rise to 8-1 from 7-1 in June.
- The latest decision wasn’t short of hawkish sentiment. Two of the nine MPC members favoured going further and repeating June’s 50bps increase. The committee stuck to its previous position that evidence of persistence in price pressures would justify further tightening. And it added new language hinting that rates would stay at current high levels for some time.
- But the MPC also acknowledged for the first time that monetary policy is now “restrictive”. Meanwhile, a range of forward-looking indicators, from producer prices to money growth, are all pointing to a rapid decline in inflation over the rest of this year and into 2024. That the MPC will ultimately have to acknowledge these developments, rather than focusing on upside risks to its forecast, means the EY ITEM Club thinks the rate rise cycle is now at, or very close to, an end.
Martin Beck, chief economic advisor to the EY ITEM Club, says: “August’s meeting saw the MPC maintain its recent approach of setting policy mainly on the basis of incoming data, rather than the expected outlook for inflation. The MPC cited the continued strength of pay growth and resilience in the economy over the late spring as justifying another rise in Bank Rate. And with changes to personnel on the committee, the majority in favour of tighter policy increased to 8-1 from 7-1 in June.
“The latest decision wasn’t short of hawkish sentiment either. Two of the nine MPC members supported going further with a larger 50bps increase. The policy statement repeated previous language that further evidence of persistence in price pressures would justify more monetary tightening. Meanwhile, there was new language around “ensuring that Bank Rate was sufficiently restrictive for sufficiently long” to bring inflation back to the 2% target, hinting that rates could remain at current high levels for some time. What’s more, despite higher market interest rates, a stronger pound and lower gas prices compared to three months ago, the Bank of England actually pushed up its medium-term inflation forecast, reflecting the assumption that previous upside risks to the forecast would crystallise.
“But the MPC also acknowledged for the first time that monetary policy is now “restrictive”, while the Bank’s latest forecast showed inflation continuing to fall below the 2% target over the next two years. For sure, a below-target forecast didn’t, once again, stop the MPC raising rates. But it will become increasingly difficult for the MPC to downplay leading indicators of inflation, from falling producer prices and inflation expectations to a significant slowdown in money growth, which all point to inflation falling back quickly over the rest of this year and into 2024.
“As a result, the EY ITEM Club thinks the rate rise cycle is at, or very close to, an end, with perhaps one more 25bps increase to come in September. The fact that the MPC is looking on course to vote for a faster pace of Quantitative Easing asset sales (an effective tightening of monetary policy) when it meets next offers another reason to bring the current rate rise cycle to a halt.
