A person stands outside the Bank of England, in London, on Sept. 13.HANNAH MCKAY/Reuters
The Bank of England said the case for higher interest rates “appeared to have strengthened” on Thursday after it nudged up its forecast for inflation at the end of the year to over 4 per cent, more than twice its target rate.
The BoE said it expected the overshoot to be temporary, but two policy-makers called for an immediate halt to the British central bank’s £895-billion ($1.23-trillion) bond purchase program, which is due to run until year-end.
Sterling rose by almost a cent against the U.S. dollar and two-year British government bond yields surged by their most since March 2020 as traders bet on an earlier rate rise by the BoE, which would be the first major central bank to hike since the COVID-19 pandemic.
The U.S. Federal Reserve said on Wednesday that it could start to slow its asset purchase program as soon as November, and earlier on Thursday Norway’s central bank raised rates, joining a handful of other developed economies in doing so.
After the BoE statement, sterling interest rate futures priced in a 90 per cent chance that the BoE would raise rates by February, up from just over 60 per cent before – though some economists say this is premature given the challenges to growth.
“It’s clear the committee is divided on how much of an issue rising inflation poses. Given the number of headwinds facing the economy this winter, we think a rate hike is unlikely until the second half of 2022,” ING economist James Smith said.
But others viewed the BoE as preparing the ground for a rate rise early next year, and Citi and J.P. Morgan brought forward their forecasts for a first BoE rate rise to 0.25 per cent from 0.1 per cent to the first quarter of 2022, with another a few months later.
“The tone of the minutes was more hawkish than expected, and opens the door both to a February hike and two rate increases next year,” J.P. Morgan economist Allan Monks said.
Surging energy prices and bottlenecks in supply chains are raising price pressures globally as Western economies emerge from the COVID-19 pandemic but have also squeezed growth.
The BoE said it had revised down its expectations for the level of gross domestic product in the third quarter by around 1 per cent from the August report, reflecting supply constraints.
But it said inflation – which hit a nine-year peak of 3.2 per cent last month – would “temporarily” rise above 4 per cent in the final quarter of the year.
A jump in natural gas prices in recent weeks – which has led to the collapse of several smaller British energy suppliers and forced the government to intervene – meant inflation risked staying above 4 per cent in the first half of 2022 too, the BoE said.
7-2 SPLIT ON BOND PURCHASES
The nine-member MPC – including new members Huw Pill and Catherine Mann – voted unanimously to keep interest rates at 0.1 per cent.
But deputy governor Dave Ramsden joined external MPC member Michael Saunders in voting to cap government bond purchases at £840-billion rather than using the full £875-billion program the BoE launched in November 2020 during the pandemic.
They saw “increasing evidence from a range of global and domestic cost and price indicators that inflationary pressures were likely to persist”, according to the BoE’s policy minutes.
But other MPC members were more cautious, especially as the government’s job furlough program will end this month, with unclear implications for unemployment and the more than a million workers who are currently receiving payments.
The benefits of waiting for more data were likely to outweigh the cost, they said – especially as tighter monetary policy would not reduce the immediate price pressures.
However, the BoE said the medium-term path for interest rates was up and policy-makers did not rule out raising interest rates before the central bank completes its asset purchases.
Governor Andrew Bailey, in a regular letter to finance minister Rishi Sunak explaining why inflation was above target, said the case for a rate rise had risen since August.
“Some developments during the intervening period appeared to have strengthened that case, although considerable uncertainties remained,” he said.
The BoE also said previous guidance it had given – which saw policy-makers split on whether certain preconditions for a rate had been met – was “no longer useful.”
Be smart with your money. Get the latest investing insights delivered right to your inbox three times a week, with the Globe Investor newsletter. Sign up today.