February inflation surprise sealed Bank of England rate rise

If any Bank of England policymakers were wavering ahead of Thursday’s decision to raise interest rates for the 11th time in succession, the shock of February’s inflation data will have stiffened their resolve.

The acceleration in consumer price inflation to 10.4 per cent, just as price pressures were expected to ease, made it all the more important for the central bank’s monetary policy committee to show that concerns over the health of global banks would not get in the way of their fight to restore price stability.

Chancellor Jeremy Hunt, who warned this week that inflation was at “dangerous” levels, made it clear that he backed the BoE’s decision, saying that rising prices were “strangling growth and eroding family budgets” and that the sooner the authorities regained their grip, “the better for everyone”.

In adopting a similar approach to that of the US Federal Reserve, European Central Bank and their Swiss and Norwegian counterparts, seven of the monetary policy committee’s nine members voted for a quarter-point increase that took the BoE’s benchmark rate to 4.25 per cent.

“We believe inflation will begin to fall quite rapidly before the summer, but as yesterday’s release for February shows, we need to see that actually happen,” Andrew Bailey, the BoE’s governor, said after the decision.

Yet like the Fed and the ECB, the MPC has left its options for future rate decisions open, saying the financial and economic outlook has become more uncertain and it wants to see more evidence of how the steep rise in borrowing costs since late 2021 is affecting the UK economy.

Investors are betting the central bank will raise interest rates one last time, to a peak of about 4.5 per cent at the end of the summer. But economists said that while higher inflation and a stronger growth outlook had forced the BoE’s hand this week, the latest rate increase could prove to be the last.

“The recent tensions in the banking system and the lingering risk of a recession should keep a lid on interest rates going forward,” said Yael Selfin, chief economist at KPMG. Ruth Gregory, at the consultancy Capital Economics, said the MPC had given a dovish message, and that while it had “stopped short of explicitly calling time on rate hikes, it is not on autohike”.

In particular, the MPC downplayed the latest jump in inflation. It said the surprising strength of core goods prices in February was largely due to volatile clothing and footwear prices, and “could therefore prove less persistent”. Service sector inflation, which is a better guide to underlying price pressures, was slightly lower than the BoE had previously forecast.

The MPC now expects inflation to fall more sharply over the next few months than it forecast at its last meeting in February because global energy prices have fallen sharply since then, and the government is extending its cap on household energy bills. In addition, wage growth in the private sector — a big concern for the BoE, because it could fuel more persistent inflation — has finally started to ease.

The BoE also said China’s reopening was likely to be disinflationary for advanced economies because it would ease strains on global supply chains and this would outweigh any effect of stronger demand.

The MPC will be hoping that by the time it next meets in May, it will have clear evidence that the steep rise in borrowing costs since late 2021 is having the intended effect and that inflation is on its way down.

By then it will also know more about the extent of problems in the global banking sector. Recent tensions have led to a rise in banks’ wholesale funding costs, the MPC noted, adding that it would “monitor closely any effects on the credit conditions faced by households and businesses”.

James Smith, economist at ING bank, said the BoE’s own surveys showed that businesses were becoming less aggressive about price increases and that if these trends continued “a pause in May is likely”.

Some business groups are already complaining that policymakers have gone too far. Suren Thiru, economist at the professional body the Institute of Chartered Accountants in England and Wales, said the latest rate increase was “overkill”, while David Bharier, head of research at the British Chambers of Commerce, called it a “blunt instrument” that did not address the fundamental causes of inflation.

However, the BoE has made it clear that if it sees evidence of “more persistent” inflationary pressures, especially in relation to wage growth and services inflation, it is prepared to raise interest rates again.

Some economists think it will have no choice. Jessica Hinds, economist at Fitch Ratings, said a tight labour market could “keep services inflation too sticky for the bank to be confident it has done enough”, while Karen Ward, at JPMorgan Asset Management, said inflation’s persistence looked “more worrying in the UK than elsewhere” and could leave the BoE “outside the central bank herd” later in 2023.

Bailey, in an interview broadcast after the MPC’s decision, suggested that the central bank would change course only when it had seen hard data to confirm its actions were working.

“We’ve seen signs of inflation really peaking now . . . We think it’s going to come down sharply, really from the early summer onwards, but we haven’t seen that happen yet. We need to see it starting to come down progressively and come back to target.”

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