It is a sign of the confusion surrounding the Bank of England’s interest rate decision on Thursday that investors are unusually divided over which direction the central bank will go.
Financial markets show that more than six in 10 investors are anticipating a hike in the cost of borrowing while a majority of City economists take the opposite view, telling a Reuters survey they expect rates will remain at historic lows, at least for the time being.
In a big week for central banks, America’s Federal Reserve will today make its much more clearly signposted announcement on tapering the scale of its monthly stimulus package, though interest rates are expected to remain unchanged.
Which way the BoE will swing, even at the 11th hour, is anyone’s guess. Ahead of one of the most finely balanced monetary policy (MPC) meetings in a decade, the Chicago Mercantile Exchange’s gauge of interest rate futures, known as BoE Watch, has stated there is a 100% likelihood of a rate rise in the UK this week.
The views of City economists chime with MPC members Silvana Tenreyro and Catherine Mann, who have aired fears that an interest rate rise now could threaten a recovery that is already weakening.
Governor Andrew Bailey, his chief economist Huw Pill and Michael Saunders, the former Citibank economist, have argued in speeches and comments that swift action could be needed to quell rising prices, swaying opinion in financial markets in favour of the BoE being the first major central bank to tighten policy.
Bailey’s remark that the bank “will have to act and must do so if we see a risk, particularly to medium-term inflation” caught the eye of many investment funds seeking to hedge against rates going up.
Deputy governor Sir Dave Ramsden is also believed to be in favour of Threadneedle Street pushing rates from historic lows after he voted with Saunders at the last MPC meeting to stop quantitative easing (QE) in its tracks ahead of a planned cut off date in December.
QE is the second strand of the BoE’s stimulus programme and was ramped up by £250bn to £895bn after the pandemic hit.
If four members of the committee have signed up to higher rates, it only takes one more to tip the scales. That puts another deputy governor, Ben Broadbent, in the frame, since the former Goldman Sachs economist has never voted against the governor in his seven years on the MPC.
Deutsche bank economists Sanjay Raja and Panos Giannopoulos said after Bailey’s intervention that they were changing their view and that the BoE would “deliver its first post-pandemic rate hike of 0.15%”, adding: “We also expect the MPC to end its current QE programme – one month earlier than expected, trimming £20bn from QE.”
Pride will be the deciding factor, according to analysts at Bank of America Securities. “Disappointing [markets] now, we think, would be Bailey’s least preferred option,” they said, though they conceded a rate rise was not a done deal.
The confusion surrounding the outcome of Thursday’s meeting stems from the wide range of often contradictory data that has emerged in recent months.
After Britain suffered its worst slump in the postwar era in March 2020, it has bounced back strongly this year. Job vacancy rates have spiralled higher and wages, which fell sharply last year, have recovered.
Inflation, after dropping to almost zero earlier this year, has climbed since the spring above the BoE’s target level of 2% to 3.1%.
At the MPC’s last meeting, it said rates would most likely need to rise by 0.5% next year to help bring down inflation to 2% over the next three years, though the minutes show it cautioned against early action.
“All members agreed the outlook for the labour market, and hence underlying inflationary pressures, was particularly uncertain.”
David Blanchflower, the Ivy League economics professor and former MPC member, said the committee should ask itself how much of the pandemic dust had cleared.
“The furlough scheme has only just ended, consumer confidence is sliding backwards and businesses are nervous about the future. How can they say the economy is strong enough to cope with more expensive credit? If anything the indicators show the economy is weakening, which means that an interest rate rise would be a colossal mistake.”
The other major central banks are a long way from raising rates. The Federal Reserve has held rates at near zero since the start of the pandemic and plans to continue adding to a $8.5tn QE programme, albeit at a slower pace.
The European central bank has pledged to maintain its policy of negative interest rates and boost QE for the foreseeable future while the Bank of Japan said last week that it plans to redouble its efforts to stimulate a lacklustre recovery in the world’s third-largest economy.
Ana Boata, head of economic research at credit insurer Euler Hermes, said Bailey’s comments “have pushed the BoE into a corner”. She believes a rate rise now could push the UK into recession, such is the pressure on household finances from higher prices, only moderate wage rises and significant tax rises due next spring.
Martin Beck, the chief economic adviser to the EY Item Club, said while some MPC members might argue the government was pouring fuel on the inflationary fire, this view was misguided.
“Tightening policy when other major central banks are still in loosening mode would seem incongruous, particularly when the UK economy was more affected by the pandemic than the US and the eurozone,” he said.