Is the Bank of England about to break interest rate precedent? | bank of england

Jhe US Federal Reserve did. The European Central Bank did. The Bank of England must now decide whether to follow suit and opt for a bigger than usual increase in official borrowing costs at its meeting on Thursday.

After slightly raising rates a quarter of a point at a time, financial markets are betting that Threadneedle Street’s Monetary Policy Committee (MPC) will announce a 0.5 percentage point jump this time around, which won’t happen. has never been produced since the Bank gained independence in 1997.

The previous time interest rates had risen by such a huge margin, John Major was Prime Minister, Ken Clarke was Chancellor and Eddie George was Governor of the Bank of England. That was in 1995, when the Treasury still had the final say on interest rates.

If the Bank innovates after independence, it will not be only because the annual inflation rate is at 9.4%, its highest level in 40 years, and is expected to increase further in the coming months. Nor will it simply be about playing catch-up after repeatedly underestimating price pressures, although that is a factor. At this time last year, the MPC predicted that inflation would peak at the end of 2021 at only 4%.

Rather, the jump will be because the Bank’s fear that inflation is taking root in the economy outweighs fears that the economy is about to enter a recession or, in fact, that she could already be one. David Blanchflower, a former member of the MPC, said he believed the UK was in the early stages of a recession which started a few months ago.

A graph showing interest rates since January 2021

What makes the committee’s job more difficult is that the economy sends mixed signals, as is often the case at turning points. Unemployment last returned to low levels in the 1970s and there are record vacancies.

Some companies – such as supermarket chain Aldi – have raised their employees’ wages twice in the past year in a bid to retain staff.

Others, including homebuilder Taylor Wimpey, HSBC bank and energy company Shell, have announced one-off payments to help staff through the cost of living crisis.

The tightness of the labor market concerns the Bank, as it evokes memories of the 1970s, when prices and wages continued to rise until inflation hit a peak of 25% after the Second World War .

Professor Stephen Millard of the National Institute for Economic Research says interest rates need to rise from 1.25% to around 3% if inflation is to be brought back on track, but he thinks to speak of a wage-price spiral in the style of the 1970s is an exaggeration.

A chart showing inflation since January 2021

Median wage settlements averaged 4% in the three months to June and even with bonuses and one-time payments on top, Millard only expects earnings growth of 6% this year, well below of the inflation rate. Wage growth is high by recent standards, he says, but not high enough to create an inflationary spiral.

The Bank’s decision will also be affected by what it thinks happens to underlying inflation, as measured by consumer prices excluding fuel, food, tobacco and alcohol. Here, the trend is encouraging, with core inflation falling for two consecutive months, falling from 6.2% in April to 5.8% in June.

Of more concern will be the steady rise in inflation in the services sector, which rose from 0.7% in June 2021 to 5.2% in June. This will be seen as a sign of price pressures being generated in the domestic economy, rather than being imported from abroad.

Chris Williamson, chief economist at ratings agency S&P Global Market Intelligence, says surveys of manufacturing and services companies show the economy is heading into a recession and the debate is about its length and depth . He says the Bank should be aware that a 0.5% increase in interest rates and a signal that the base rate is heading towards 3% will push the economy into an even deeper recession.

Williamson worries that many of the indicators that the economy is doing well could quickly reverse if interest rates rise quickly. He warns this ‘bullwhip effect’ could mean that business closures, which have remained low during the pandemic, become more widespread, while unemployment, which has fallen steadily over the past year to a low 48 years old, begins to increase.

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The housing market, which has shown resilience since the start of the pandemic, could also start to weaken and prices could start to fall, pushing some households into negative equity.

Tim Bannister of online property portal Rightmove says first-time buyers are facing average monthly mortgage payments 20% higher than at the start of the year, due to rising interest rates and asking prices. Meanwhile, existing homeowners, many of whom are nearing the end of a fixed-rate mortgage, are facing higher monthly bills.

“With each interest rate hike, homeowners contribute about an additional 1% of their gross salary on average to a mortgage, and a 0.5% increase in the base rate would bring average monthly mortgage payments to 40% of their salary,” he said. .

Another sign of an impending recession can be found in the warehouses of retailers, manufacturers and construction companies. For much of the past year, companies have stockpiled raw materials and goods in short supply to ensure they can fulfill contracts and supply customers.

However, figures from the United States show that a slump in consumer demand has left businesses with mountains of unsold clothing, household items and furniture. Inventories were high to support sales a few months ago. Now the warehouses are cluttered with things that need to be unloaded at a discount, with few potential buyers.

Williamson says the problems facing Walmart and Costco in the US will also apply to large retailers in the UK and across Europe.

Krishna Guha of investment banking advisory firm Evercore expects the Bank to “join the global trend of oversized rate hikes” with a half-point increase to 1.75%, although only with some reluctance because of the pronounced slowdown in the economy.

Like most other analysts, Guha will be looking for clues as to where – with the UK on the brink of stagflation – the Bank will go next.

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