On February 1, the Bank of England’s Monetary Policy Committee voted 7-2 in favour of a 10th consecutive interest rate increase.
This decision, which raised rates by 50 basis points to 4 per cent, coincided with the clearest signal yet that the base rate might be nearing its peak when the BoE said it would only raise rates further “if there were to be evidence of more persistent [inflationary] pressures”.
A fortnight later, consumer price index data revealed that inflation had dipped by 0.4 per cent to 10.1 per cent – a five-month low in the UK. As a sharper decline than many experts had predicted, some analysts now think the central bank will hit pause.
These views were strengthened on February 16 when BoE chief economist Huw Pill, speaking at Warwick University, warned that there is a risk of “over tightening” for the central bank now.
However, UK price pressures remain at higher levels than in other economies, mostly due to energy costs. Meanwhile, average pay is growing at its fastest rate for more than 20 years. Clearly, a balance must be struck where growth is concerned, given that the UK economy is set to be the only major economy to shrink in 2023.
Meanwhile, further rate increase risk creating a deeper recession, especially as the full impact of previous hikes have still not yet been felt.
This was demonstrated by the Silicon Valley Bank crash earlier in March, and the Credit Suisse takeover last week, which many analysts argue was caused by the speed at which rates have increased, potentially indicating weakness at the heart of the financial system.
Clearly, the BoE is in a difficult position as March’s interest rate decision looms, so where does it go from here?
The battle with inflation
First, what inflationary pressures will be at the forefront of the MPC’s mind in the months to come?
The labour market is one example. For the most part, BoE governor Andrew Bailey and his colleagues have placed much of the blame of the upward pressure on wages on a shortage of workers – with vacancies dipping across the country, this inflationary pressure might be expected to be receding.
However, statistics show that the problem remains, with January’s wage data coming in hotter than expected. In the fourth quarter of 2022, average earnings were 6.7 per cent higher than in the same period in 2021, presenting a major problem for the BoE – when salaries rise, businesses typically raise prices to compensate, creating an inflationary spiral.
For the MPC members who believe in further tightening, this adds credence to their argument.
Elsewhere, energy costs will be monitored closely. According to the Office for National Statistics, household bills account for 26.7 per cent of the current rate of inflation, so inflation will recede at pace if they start to decline. Currently, however, the cost for consumers remains elevated, even though wholesale prices have dipped.
