The Times shadow MPC: Banks should raise interest rates by 5%

The majority of the shadow monetary committee members think that Bank of England should go against expectations and opt for an increase of a half-point.

Bank of England’s decision is made amid renewed turmoil on the mortgage market. Borrowing costs for homeowners are now higher than 6 percent for two-year mortgages, for the first since last year’s mini budget. Lenders like TSB were forced to pull some mortgage products from the market this week, as markets expect further rate increases this year.

Investors now expect the base rate to reach a maximum of 5.75 percent by the end the year. This is up from the current 4.5 percent. The expectation of higher interest rates has also triggered a sale-off of UK government bonds. This in turn has pushed the yield on gilts with a two-year maturity to its highest level since the 2008 financial crisis. When bond prices drop, yields increase.

The majority of the shadow MPC believes that the Bank should ignore concerns over mortgage rates, and the rising cost of borrowing from the government to focus solely on inflation. The majority of economists do not agree with the shadow MPC, and believe that the Bank will continue to increase interest rates by a quarter percentage point.

David Roberts, the chairman of Bank’s Court, stated yesterday that rate-setters will not deviate away from their legal goal to bring inflation to 2 percent. He told the Lords economics committee that they would keep a laser focus on getting down inflation and achieving our financial stability goal in a difficult time.

The MPC must send a strong signal that it intends to stop the spiral of rising wages and prices that is gaining momentum. The private sector is now experiencing regular pay increases of 7.6 percent, and the services sector is gaining momentum as goods inflation subsides. Pay increases at the current rate could increase services inflation.

The real economy is resilient, and the labour markets remain tight. MPC made a mistake by being too cautious in raising interest rates earlier in the cycle. The MPC should not repeat the mistake. It should show that it is willing to do whatever is needed to reduce inflation by announcing a 50-basis point move at the meeting this month and explaining why this is required.

Karen Ward, JP Morgan Asset Management, said that the Bank must show a decisive resolve in combating headline inflation.
The Bank is now in a difficult position because of its earlier hesitation. The Bank waited too long to see if inflation would disappear on its own and underestimated second-round effects, which are now apparent in the acceleration of wage growth. It didn’t adhere to the “stitch-in-time saves nine” rule and will now have to increase rates even more to bring inflation to target.

In the months to come, a growing number of households are likely to switch from lower mortgage rates to much higher ones. It will have a major impact on their incomes. This is not the whole story. Demand is also supported by the growth of wages at 7%. The main purchasing managers’ index for business services does not indicate a significant slowdown in demand.

Unfortunately, I don’t believe that the Bank will be able to return inflation to its target without a contraction of activity to realign supply with a weaker demand. Further hesitation will only lead to a further loss of trust. It is important to act quickly. In order to achieve this, I will vote for 50 basis point at the Thursday meeting.

Recent data about inflation, wages and expectations, as well as the demand, have cast doubts on how quickly inflation could return to its target. The credibility of the Bank has been compromised. It is clear that the Bank should reaffirm its commitment to maintaining price stability. This would mean an increase of about 50 basis points.

This would be risky for many reasons. If the Bank was accused of over-pressuring the market, and it led to headline bankruptcies or a recession that was significant, they could face severe criticism.

As a certified coward I will vote for the standard 25 basis-point increase, but I’ll always question if it is the right policy.

The inflation is showing signs of resilience, and the growth in wages is one sign. I would raise Bank Rate by a half-percentage point, in the hopes that increases can be paused at the next meeting. For that to be justified I would need to see signs of inflation easing or, at the very least, a material slowdown in the labor market. This could be achieved through an increase in the labour supply.

Banks should not give guidance on future interest rate paths. The MPC votes only on current rates and not future ones. Any forward guidance is a gamble.
Interest rates will continue to rise as April’s inflation, wages and private sector growth are both higher than anticipated.

Before the May inflation data is released, we already know that food prices may have reached their peak, mortgage holders are still feeling the effects of previous rate increases, business confidence has stagnated in May, and insolvencies have risen sharply. We also know that people previously excluded from working because of caregiving responsibilities are now finding ways to work remotely. A 25 basis-point increase feels reasonable in the absence of any new information.

According to the latest data on the labour market, employers still feel they can increase prices in order to cover wage increases. This is a classic sign of demand exceeding supply. Therefore, a rate increase seems justified.

The risk is that the UK will see inflation become more embedded than in the United States or the European Union. This is due to our poor performance in terms of supply and the absence of regional factors which balance the economies on the continent. The Bank cannot allow this to happen.

A 25-basis point increase is likely to be supported by the majority of MPC Members. Given the uncertainty, it makes sense for them to “feel their way forward”. However, I’d be inclined to vote in favor of a 50-basis-point increase this time because it would shock the expectations.

I wouldn’t say that the market expects a further increase.
It takes time for monetary policy to take effect, and I’m not sure if the effects of the rate increases we have already seen have been fully felt. Another 0.25-percentage-point increase will not be enough to dampen inflation expectations and wage demands and a contraction in activity may be the only solution.

The cumulative effect of all the rate increases we’ve seen in the past, plus a 0.5 percent increase this month, could lead to an unexpected and unpleasant event. I’m not worried about the banks as they have a lot of capital, but after many years of low interest rates other parts of the economy might not be protected. So I am voting for a quarter-point hike.