The Bank of England (BoE) lifted interest rates by raising its benchmark from 0.10% to 0.25% on Thursday. The decision came as a surprise since it is the first major central bank to take the step since the pandemic’s onset.
The bank’s Monetary Policy Committee (MPC) has set monetary policy keeping sustainable growth and employment in mind to meet the 2% inflation target.
The MPC’s majority voted to increase the Bank Rate by 0.15% to 0.25% at the December 15, 2021 meeting. The Committee further voted to maintain the stock of sterling non-financial investment-grade corporate bond purchases by the Bank of England, endorsed by the issuance of central bank reserves at £20 billion.
Another vote was to maintain the stock of UK government bond purchases that will be endorsed by central bank reserves, at £875 billion. The total target stock of asset purchases is at £895 billion now.
The November Monetary Policy Report shows the central projections of MPC indicating the recovery of global and UK GDP from the effects of Covid-19 in the near term. However, financial markets were conditioned to expect an increase in the Bank Rate. The upward pressure on CPI inflation was believed to deplete with time. And as supply disruption smoothed down, the global demand rebalanced from goods to services, and energy prices ceased to rise. Earnings growth was also anticipated to drop from its current rate. Inflation was then expected to fall back materially from the coming year’s second half.
After the November MPC meeting, the new variant of Covid emerged and is spreading rapidly within the UK and globally. This new variant is supposedly more transmissible than the Delta variant and poses a new risk to public health. The risky asset market saw a sharp drop followed by the news but has now recovered—the long-term advanced govt. Bond yields have since dropped.
The global GDP level of 2021 Q4 will largely be in line with the projection of the November Report. Regardless, consumer price inflation in advanced economies has surged more than expected. The Omicron variant threatens activity in early 2022; the medium-term global inflation pressures are not clear. Global cost pressures have been strong.
The Labour Force Survey unemployment rate dropped to 4.2% in the three months to October, with the number of employees rising continuously in November. Available data do not indicate that the closure of the Coronavirus Job Retention Scheme led to a weak labor market. The LFS unemployment rate will largely fall around 4% in 2021 Q4 compared to the 4½% projection in the November Report. Bank staff is estimating the underlying earnings growth to remain above pre-pandemic rates. The Committee continues to look at upside risks in the projection for pay in the November Report.
The twelve-month CPI inflation rise triggered the exchange of open letters among the Governor and the Chancellor of the Exchequer published with this monetary policy announcement.
Considering the November Report projection, core goods have seen quite an upside and, to some extent, also services price inflation. According to bank staff, inflation is expected to remain around 5% for the majority of the winter period and will peak at approximately 6% in April 2022. In addition, the further increase accounts for largely the lagged impact on utility bills of wholesale gas prices developments.
Cost and price pressures indicators have stayed at record levels recently. The Bank agents expect price increases for the next year driven largely by pay and energy costs. Even so, CPI inflation is expected to fall later in the year.
The MPC’s remit clearly stated that the inflation target applies at all times, replicating the importance of stable prices in the UK monetary policy framework. The framework also considers the occasion of inflation wavering from the target followed by shocks and disturbances. The recent instances have subjected the economy to huge, repeated shocks. Given the lagging changes in monetary policy and its effects on inflation, the Committee focuses on medium-term prospects for inflation. It considers the appropriate policy stance and includes medium-term inflation expectations rather than transient factors.
The Committee, in its November meeting, announced that increasing the Bank Rate would be necessary to return CPI inflation to the 2% target in a sustainable manner. However, this is on the condition that the incoming data, primarily the labor markets, were in line with the central projects in the November Monetary Policy Report.
The latest economic developments show that these conditions have been adhered to. The labor market is tight and progressively continues to tighten; there are also indicators of an extraordinary persistence in domestic cost and price pressures. The Omicron variant is expected to affect near-term activity but what it has in store for medium-term inflationary pressures is unclear.
The Committee, in its judgment, states that it warrants an increase in Bank Rate of 0.15% points.
The MPC will review developments as part of the forthcoming forecast round ahead of the Monetary Policy Report February 2022, including the emerging evidence on the Omicron variant’s hurdles for the economy. In addition, the Committee will continue focusing on the medium-term prospects for inflation as it usually does.
The Committee also persistently suggests double-sided risks involved in the inflation outlook in the medium term. Still, some monetary policy tightening over the forecast period will likely be necessary to meet the target. Therefore, the Committee will assess the risk balance around the medium-term inflation considering relevant data as they materialize.