Two new issues were presented to the Bank of England’s Monetary Policy Committee as they deliberated on Thursday on a second interest rate increase.
Andrew Bailey, the BoE governor, was among the nine MPC members who had to take into account the good news about a sharp drop in wholesale energy prices and then incorporate this in their new pessimistic view on the UK’s potential growth without inflation.
It was a messy result. The BoE’s new projections showed that inflation was falling below 2 percent by next year. However, MPC members voted to increase interest rates by 7 to 2.
Senior BoE officials described the decision as akin buying insurance against future price increases — in case inflation forecasts were wrong. In December, consumer price inflation was at 10.5 percent, down from 11.1 percent in October.
Bailey stated, “It is too early to declare victory over inflation just yet.” “We must be certain that inflation is under control.”
In the minutes, the majority of MPC members stated that they place more emphasis on strong wage and job data than on “relatively low [weight] on medium-term projections for inflation.”
They also stated that they might increase rates if they want to make sure inflation is defeated.
Sir Dave Ramsden is the BoE deputy governor. He stated that the MPC had to “use [the central bank’s forecasts] in an even more nuanced manner than we did in 10 years”.
However, the forecasts indicated that MPC members did not need to raise interest rates at their February meeting.
The MPC considered the median, mode and mean of the forecasts. Inflation rates of 4 percent left it too low within two years, and much lower in three years, with a minimum of 50% chance that it will fall below 1 per cent.
George Buckley, Nomura’s chief UK economist, stated that “the bank’s end-horizon vision for inflation [in 2026] is exceptionally weak”.
According to the BoE inflation forecasts, interest rates could fall very quickly if they prove correct.
Bailey confirmed the same in a circular manner, saying that “If the economy develops as in central case [of forecasts], then we will adjust policy accordingly.”
However, even though inflation prospects were positive, BoE growth projections were not.
On Tuesday, the IMF sent shockwaves across Atlantic with the prediction that Britain’s economy would fall into recession this fiscal year. It was the only industrialized country to do so.
The BoE didn’t differ too much. The BoE’s 2023 forecast was slightly less optimistic than that of the IMF, with a 0.7% drop in UK gross domestic products in the fourth quarter, compared to the same period a year ago. The BoE also predicted stagnation in 2024. However, the central bank forecasts that the fund will experience growth of 1.8 percent.
KPMG economist Yael Selfin said that the BoE’s forecasts for short-term growth would be difficult to read for Britons. She said that the central bank paints a grimer picture of the UK’s economy than its peers, as it is facing stronger headwinds.
Although the BoE expects a less severe and shorter recession than MPC members at their November meeting expected, the details of the BoE’s forecast show that GDP will not reach pre-coronavirus levels before 2026.
Ben Broadbent, another BoE deputy Governor, stated that the IMF was likely correct in naming the UK as the country with the lowest economic prospects among industrialized countries this year. However, he said that the differences are small.
He highlighted the unique problems that the UK was facing in the short-term, such as declining participation in the labor market, particularly among the elderly. He also pointed out the UK’s greater dependence on natural gas than other European countries, which will continue to lower British household incomes and faster conversion of higher interest rates to more expensive mortgages which would reduce consumer spending.
Broadbent tried to be optimistic about the future by saying, “These aren’t things that will last forever.”
The BoE’s long-term outlook on the economy was grim. The new view of the MPC members was based on the belief that the UK can no longer sustain a growth rate above 1% per year without creating inflation. They believed that 1.5 percent annual growth would not produce inflation.
Officials at the BoE did not attempt to minimize the difficulties of living with an economy that grew at 2.5 percent per year before the financial crisis and could sustain around 1.7% before the coronavirus.Bailey blamed “the shift in the trading relations with the EU”, as well as the effects of the pandemic, higher energy prices and Russian invasion of Ukraine on Bailey. These had impacted UK productivity growth and reduced size of the labor force.
The BoE recognizes that the UK has few growth engines, making it difficult for both households and businesses to thrive, even though the central bank may be able to reduce interest rates in the near future.
James Smith, research director of the Resolution Foundation, a think tank, stated that: “Families are experiencing a sharp two year living standard downturn, while Britain is suffering from a 20-year stagnation in growth — the worst since interwar years.”