View of the Royal Exchange and the Bank of England in London.
Vuk Valcic | SOPA pictures | LightRakete | Getty Images
LONDON – The Bank of England is expected to keep rates at record lows and continue its massive asset purchase program on Thursday, but investors will be on the lookout for signs of tightening over the next year.
The central bank’s latest monetary policy meeting will be a swan song for restrictive chief economist Andy Haldane, who warned that the “inflation tiger” is on the way and urged policymakers to close the bank’s $ 895 billion quantitative easing program Pounds ($ 1.24 trillion) around £ 50 billion.
UK consumer price inflation was 2.1% in May, beating projections and beating the bank’s 2% target for the first time in nearly two years. Core inflation, which excludes volatile food and energy prices, rose from 1.3% in April to 2% in May.
The bank predicts that inflation will hit 2.5% by the end of the year, but the consensus remains that the spikes in inflation will be temporary. Meanwhile, the labor market and other economic indicators are showing signs of recovery, fueling speculation that the bank may point a way out of its extraordinarily loose monetary stance. The key interest rate remains at a historic low of 0.1%.
The US Federal Reserve recently surprised markets with a restrictive turnaround, raised inflation expectations and brought forward its tightening plan to forecast two rate hikes in 2023.
At the BOE meeting in May, the Monetary Policy Committee split on whether to scale back quantitative easing, but signaled a future reduction in asset purchases.
So far, however, it has not given any binding information on the time of the first rate hike and reiterates that clearer and more sustainable progress in the economic recovery needs to be demonstrated.
Labor, inflation and the delta variant
“Economic data has been encouraging for the past few weeks – and it is indeed clear that the economy is now outperforming last summer when restrictions were also low,” said James Smith, ING’s developed markets economist.
“But the bank’s growth stance is already on the more optimistic end of the spectrum, and the proliferation of the new Delta variant adds an additional dimension of uncertainty (although we currently assume the economic impact is unlikely to be huge). We also doubt whether the bank will feel too compelled to change market expectations in their current form. “
ING expects an initial rate hike in the first quarter of 2023, with inflation easing by mid-2022 as the spikes triggered by the reopening of the economy subside and pressure on policymakers eases. However, analysts at the Dutch bank said in a note on Monday that they would “certainly not rule out” an earlier Hawkish swing.
“Possible triggers could be faster dissolution of household savings as the economic outlook is particularly sensitive to even small percentage changes in savings spent (the BoE estimates around 10%),” said Smith.
“Wage growth is also vital and there are anecdotal reports of hospitality staff shortages, although we believe this is likely to prove temporary.”
Similar to the recent trend in the US, the labor market suggests some analysts that inflation may be more resilient than previously thought. The Association for Recruiting and Employment saw job vacancies rise to its highest level in 23 years in April, with problems in the health, hospitality, transport and construction sectors.
This has resulted in higher wages, with annual earnings growth rising to 5.6% in the three months to April, noted Katharine Neiss, chief economist for Europe at PGIM Fixed Income.
However, Neiss expects the BOE to take a wait and see approach during this meeting as rising cases of the Delta-Covid-19 variant remain a cause for concern and large numbers of UK workers remain on vacation.
“The most important Brexit milestones for a further dintegration of trade between the UK and the EU will come later this year, which further unsettles the prospects,” she said.
“After all, unlike the US, the UK government has taken a decidedly restrictive stance on fiscal policy, stressing the need to balance books and control spending. These factors are expected to weigh on the recovery and inflation for the very near future. “
In order to mitigate any inflation hysteria, the MPC must emphasize vigilance, added Neiss.
“Here, the BOE has an advantage over its larger DM competitors – as a small open economy it has experienced significant inflation overruns – both in terms of extent and longevity – which the MPC has successfully brought back to its goal while it remarkable level of stability in medium-term inflation expectations, “she said.
“While the MPC would do well to communicate that it will keep a close eye on inflationary pressures at its next meeting, it does not need to knock on the table.”