Though more difficult to quantify and monitor, the effect of government fiscal packages throughout the pandemic – such as the furlough scheme – presents further difficulty.
In congress with a sharp rise in personal savings during the pandemic, consumers were left with a lot more money to spend when society reopened. The result was a strong economic recovery, but, combined with the hangover of pandemic supply constraints, this resulted in bottlenecks and higher prices.
Need to balance with growth
Despite these inflationary pressures, the BoE cannot ignore the risk that further economic tightening poses for growth.
Last year, the UK economy avoided a recession by the barest of margins, with gross domestic product declining by 0.5 per cent in December. This came after the economy shrank by 0.2 per cent in the third quarter of 2022. While the UK is not yet in a technical recession, growth is too weak to avoid a significant economic downturn.
According to the International Monetary Fund, the UK economy will shrink in 2023 and perform worse than other major economies, including Russia. But with the UK lagging behind, economists are arguing that further interest rate rises may result in a deeper recession.
Similarly, as a result of quick successive interest rates increases, there are now concerns that there are growing signs of financial stress that can be linked to the growing cost of borrowing.
The Silicon Valley Bank collapse, for instance, could be indicative of a wider issue within the financial system, meaning that the BoE could be forced into pausing its hiking cycle at an earlier date than initially planned in order to protect the banks, as well as the many UK tech start-ups that have been caught up in the SVB fallout.
What can we expect in the months to come?
Before the SVB crash, the markets had priced in further rises, peaking at 4.9 per cent for year-end. However, the probability of a 0.25 percentage point increase has now dropped from close to 100 per cent to 64 per cent, with the argument being that banks will exercise their own caution when issuing loans in the coming months over financial stability concerns.
As such, fewer loans will be delivered, alleviating the pressure on the central bank to cool the economy.
That being said, the crisis faced by another bank this week – namely Credit Suisse – muddies the water further for the MPC. As such, while the BoE have insisted that the UK’s financial system is ‘safe and sound’ the more dovish members of the MPC may see last week’s events as further reason for hitting pause on further rate rises for the time being.
