The Bank of England’s Monetary Policy Committee (MPC) took a slightly more hawkish tone in its policy statement released on Thursday and suggested that the case for tightening monetary policy had gotten a bit stronger recently.
However, the weaker economic outlook takes a near-term rise off the table. Uncertainties around the labour market and the ending of the furlough scheme later this month also meant that the MPC preferred to wait until it had a clearer view before taking any policy decision. Financial markets still expect the first interest rate hike to come early in 2022 – but we think a hike early in the second half of next year is more likely.
While the committee voted unanimously to keep interest rates at 0.10%, Dave Ramsden joined Michael Saunders in voting to finish asset purchases early. The 7-2 split illustrates the conundrum facing the MPC. On the one hand, the economy has weakened since the August MPC meeting. Indeed, the Bank revised down its forecast for the level of GDP in Q3 by 1%, which would leave the economy 2.5% below its pre-coronavirus level.
On the other hand, inflation has risen faster than the Bank expected in August and the MPC now thinks it will rise to slightly above 4.0% in Q4. The recent rise in energy prices represents a further upside risk to its forecasts.
But the key variable determining the outlook for inflation and interest rates is still the labour market. A record number of vacancies and rising underlying wage growth suggests the market is tightening, even though the number of people in employment is still well below its pre-pandemic level. The MPC said, ‘the outlook for the labour market, and hence underlying inflationary pressures, was particularly uncertain, and that some of this uncertainty should be resolved over coming months. Hence, there was a high option value in waiting for that additional information before deciding if and when a tightening in monetary policy might be warranted’.
That’s Bank speak for, ‘we want to wait and see how the labour market responds to the ending of the furlough scheme before we make any moves’ – essentially, the MPC has pressed pause on any decisions until at least November.
Overall, the minutes to the meeting proved a bit more hawkish than we had expected. The MPC abandoned its guidance that ‘it did not intend to tighten monetary policy at least until there was clear evidence that significant progress was being made in eliminating spare capacity and achieving the 2% inflation target sustainably’, saying that it was no longer useful. Instead, it said it would continue to focus on the medium-term outlook for inflation rather than transitory factors.
The committee also reiterated its guidance that ‘some modest tightening of monetary policy over the forecast period was likely to be necessary’ but took that a step further, saying that ‘some developments during the intervening period appear to have strengthened that case’ and ‘current elevated inflationary pressure could potentially lead to some second-round effects on consumer prices’.
All this suggests that the MPC is becoming more concerned about rising inflation and is getting closer to raising interest rates. Indeed, having seen the minutes, financial markets now expect the MPC to hike rates sooner than they did before.
We still think that a rise in the second half of next year is more likely than in the first, although potentially in August rather than November. After all, core inflation will still fall back sharply next year and there’s not much monetary policy can do about rising global energy prices or a shortage of shipping containers.
In fact, if the MPC tightens policy too soon it risks demand and inflation being too weak when supply normalises. This would increase the risk that the pandemic’s damage to the economy becomes permanent. That’s a key reason for why we think that, until the economic recovery is more established, the committee will give a bit more weight to supporting the economy, look through the surge in inflation and keep interest rates low.