The latest Bank of England MPC meeting minutes appear very similar to last month’s, at least on the surface. There was a unanimous vote to leave interest rates unchanged. The quantitative easing asset purchase programme is still being maintained at £875 billion. However, there are signs of a change in direction within the committee.
Deputy Governor Dave Ramsden has joined Michael Saunders to call for an early end to the government bond purchase programme. At the same time, there are strong signs that we will see a tightening of monetary policy in the short to medium term. This comes with the UK economy under pressure; inflation is forecast to remain stubbornly high, the energy sector is in crisis and supply chains across the UK are floundering.
Prospects for the UK economy
Since the UK economy emerged from the Covid pandemic, we have seen monthly increases in forecast economic growth. However, this has come to a screaming halt after this week’s MPC meeting. The Bank of England has revised third-quarter UK GDP growth forecasts of 2.9% down to 2.1%. This is a sizeable reduction. More so when you bear in mind, the forecast growth figure of 2.9% was mentioned in the August MPC meeting just a few weeks ago. This will also impact the previous annual forecast growth of 7.25% for 2021 (we await a formal revision).
At this moment in time, there are three significant issues for the Bank of England to address:
- Bottlenecks in the supply chain
- Sky-high energy prices
- Stubbornly high inflation
A few weeks ago, there were signs of bottlenecks in the supply chain and an increase in energy prices. However, not even in their wildest nightmares would anybody forecast the situation we are in today.
One of the main issues with supply chain bottlenecks is a lack of HGV drivers. While the UK government is looking to address the situation as quickly as possible, there is no immediate fix. As a consequence, it isn’t easy to forecast with any absolute certainty when this might end.
Unemployment in the UK
The employment market in the UK is a mixed bag at the moment. On the one hand, we have unemployment falling to 4.6% in the three months to July 2021. Payroll data also shows that the number of people in employment has surpassed the figure from the fourth quarter of 2019. At the same time, a surprisingly high 1.7 million people were still furloughed as of July 2021. Recruitment agencies are reporting record demand for personnel across many different sectors. This has prompted an increase in wage inflation, which will not help the MPC control consumer inflation.
The surprising number of people still furloughed would suggest that we have yet to feel the full force of Covid related redundancies in the UK. In a perfect world, those facing redundancy would help to alleviate the current skills shortages and record employment vacancies. But, unfortunately, there is no certainty that they will have the necessary skills to fill the gaps.
Inflation in the UK
Inflation, seen by many as the devil incarnate, has been relatively strong for some time in the UK. Usually, when the Bank of England downgrades quarterly economic forecasts by such a heavy amount, you would expect a reduction in inflationary pressure. This would suggest reduced consumer demand, which would eventually filter through to weaker pricing pressure. However, that is not the case!
At the moment we have food and goods shortages across many parts of the UK. This in itself has added to the upward pressure on inflation. Then we have the ongoing energy crisis, which will have a material impact on the inflation figures. Consumer price index inflation now stands at 3.2%, way above the Bank of England’s 2% target rate. The August MPC meeting suggested inflation may peak just above 4% in the latter part of 2021 then fall back towards the 2% target. This forecast has also been revised!
The Bank of England expects inflation to rise above 4% in the latter part of 2021. It is forecast to remain there into the second quarter of 2022. Hopefully, the energy crisis will be resolved relatively soon, but the supply chain issues may take longer to sort out.
UK interest rates
The MPC voted to leave UK base rates unchanged at 0.1%, but changes cannot be too far away. Reuters reports that interest-rate futures are now pricing in a 90% chance of an increase in rates by February 2022. Before this month’s MPC minutes were released, the chances of an increase were around 60%. However, it is fair to say that opinion on interest rates is divided, with some experts believing it will be the latter part of 2022 before we see the first interest rate rise.
On the one hand, the MPC will be conscious that inflation is running way too high, and an increase in interest rates would help to reduce this. On the other hand, if supply chain issues remained for some time, this would undoubtedly impact short to medium-term economic growth. This would typically see an increase in unemployment, although the recruitment agencies have never been busier, prompting a reduction in base rates. Who would be an MPC member!
Where does the MPC go next?
On balance, the MPC will probably be proved correct in delaying the eventual rise in UK base rates. There is much concern about energy prices, but surely this can only be a short-term issue. The knock-on effect of long-term high energy costs would be debilitating for businesses and push many households into poverty. Scarcity of stocks and panic buying before Christmas look likely to push food inflation to uncomfortable levels, exacerbating what is already an extremely challenging supply chain bottleneck.
The Office for National statistics believes that, come the end of 2021, the UK economy will be around 2.1% below its pre-covered pandemic level. Compare this against earlier hopes that the UK economy would be back to parity by the end of 2021, and we can see the challenges ahead. It isn’t easy to see any positive news regarding UK economic growth in the short to medium term. Consider this in tandem with stubbornly high inflation, and you have a significant challenge for the MPC.
If economic growth continues to flounder, then an increase in base rates won’t help. On the flip side, inflation will remain stubbornly high at dangerous levels without an increase in UK base rates. Not all parties will be happy when the Bank of England finally does increase UK base rates, as not everybody will benefit in the short term.