Andrew Bailey, the Governor of the Bank of England, is under immense pressure today after news that the MPC voted to leave interest rates unchanged. Amidst a raft of severe criticism in the financial press, he is fighting to save his reputation. Just days ago, the Bank of England seemed to suggest that interest rates were “set to rise”. Consequently, this was priced into money markets, and mortgage companies moved their rates higher – these moves now look foolish.
Fast forward to the latest MPC meeting, and two members out of nine voted for an immediate rate rise to 0.25%. We also know that three members favour ending the bank’s quantitative easing programme, which involves huge asset purchases. Is the Bank of England misleading markets, or has there been a communication breakdown?
Prospects for the UK economy
Nobody envies the MPC’s position regarding UK interest rates as the economy struggles with supply issues while inflation is out of control. The MPC minutes again highlighted the worldwide supply chain bottleneck which is impacting the UK economy. Consequently, the forecast economic growth rate in 2021 was trimmed to 7%, with a more significant cut, from 6% to 5% in 2022. As the post-pandemic “catch-up” process ends, growth is forecast at just 1.5% in 2023 and just 1% in 2024.
The MPC still believe that the UK economy will return to pre-pandemic levels in the first quarter of 2022. A mixture of reduced supply growth, higher energy prices and “fading” monetary and fiscal policy support should temper demand. This is the main reason for the relatively low economic growth expectations for 2023 and 2024. Interestingly, despite massive labour shortages across many different sectors, the MPC believe that towards the end of 2021, pay growth will start to fall back.
Unemployment in the UK
The Labour Force Survey unemployment rate stood at 4.5% in the three months to August. The MPC also noted that over 1 million people were furloughed just before the Coronavirus Job Retention Scheme closed in September. This was higher than August expectations but is unlikely to lead to a significant increase in unemployment due to ongoing recruitment issues.
It is safe to say that UK unemployment is unlikely to reach anywhere near the worst-case forecasts of recent months. A mix of surprisingly few redundancies and ongoing recruitment issues will counterbalance each other. The real challenge for UK unemployment will come in 2023 and 2024 when economic growth will be more subdued. Many would argue that excessive pay growth and recruitment issues will place a heavy burden on companies in the future. However, much of this burden may not materialize until the economy does start to cool and see the emergence of spare capacity. Even though spare capacity is likely to be minimal in the early days, it will impact the cost of goods and services and, ultimately, profit margins.
Inflation in the UK
While specific issues are affecting UK inflation at the moment, just lately, the MPC has been forced to increase their forecasts for the short to medium term. While the 12 month CPI inflation rate fell from 3.2% in August to 3.1% in September, it is still expected to rise to 4.5% in November and 5% in April 2022. In recent times, the Bank of England has suggested inflation would peak at around 3%, then 4% and now 5%. At the moment, the MPC is forecasting inflation to ease significantly in the second half of 2022. However, a side note suggested that the degree of easing will depend on energy prices falling back. At the moment, can the MPC members be confident of this?
It is safe to say that inflation is now approaching dangerous levels. The time for talking about a potential rise in interest rates is over. Markets are demanding a tightening of monetary policy as a means of reducing spending. Ongoing low finance costs and a considerable increase in energy prices are feeding the monster that is inflation. There are growing concerns at the lack of action on inflation and the fact that it is still expected to peak at 5% in 2022, despite interest rates increasing “over coming months”.
If this is a best-case scenario for the Bank of England, what is the worst-case scenario?
UK interest rates
We are now in a bizarre situation where the Bank of England suggests that interest rates will need to rise “over coming months”. Is this not what we have been hearing for the last few months?
When questioned about his comments, Andrew Bailey pointed out that numerous MPC meetings were planned over the coming months. However, in what many see as a market concession, the MPC today “signalled” that interest rates will rise to near 1% by the end of 2022 to combat rising inflation. The problem is that many financial institutions and investors believed they had received “signals” last month that interest rates would rise in November. Thus, we are now at the stage where the governor “who cried wolf” is in danger of seeing future signals discounted by the market, or worse, ignored.
Under the former stewardship of Mark Carney, economists experienced several false dawns and unreliable forecasts. There were hopes that Andrew Bailey would be a “safe pair of hands” with a more transparent and open era. The difficulties caused by the pandemic, energy price rises, and the end of furlough, together with supply chain issues, have been well documented. However, a constant misreading of the situation has caused confusion and concern, with recent forecasts described as unreliable.
What will it take for interest rates to rise?
Before the November MPC meeting, reading the financial press led many people to believe that interest rates would rise from 0.1% to 0.25%. Many money market experts are astonished at the lack of action by the MPC. The constant promise of increases tomorrow, when tomorrow never comes. Inadvertently, after last month’s indication that rates would rise in November, we saw mortgage providers increase their rates, and money market interest rates creep higher.
While money market interest rates dipped on today’s announcement, there is now even more certainty in the minds of economists that December will see the first of several small rate rises. In hindsight, we may find that the Bank of England MPC read the markets perfectly in the months and years ahead. Alternatively, the reputation of Andrew Bailey and his colleagues on the MPC could dwindle even further. So who is your money on?
Image Credit: David Herraez Calzada / Shutterstock.com