Interest rates set to be held as Bank backs ‘defensible strategy’
The Bank of England is set to hold interest rates at a crunch decision this afternoon as policymakers will opt for a “defensible strategy” in the face of uncertainty from the war in the Middle East.
Markets have all but priced in a pause in interest rate cuts on Thursday, with most Monetary Policy Committee (MPC) members expected to highlight the inflationary risks posed by a prolonged war.
Economists at Pantheon Macroeconomics said holding rates was a “defensible strategy” given Bank officials will be keen to see how a spike in oil prices affects households and firms’ price expectations over the coming months.
Analysts said: “Five years of near-continuously above target inflation and elevated household surveys of expectations mean the MPC cannot be confident that an energy shock will cause a ‘transient’ inflation rise.
“Rate-setters will want to avoid the Ukraine mistake too,” they added, referring to the Bank’s own admission that it failed to predict the persistence of inflation after 2022 since it underestimated stickiness in wage growth.
The Brent Crude oil price has jumped by over 40 per cent since the start of the war while a European gas benchmark price, the Dutch Title Transfer Facility (TTF), has spiked by around 70 per cent.
Inflation dropped to three per cent in the year to January while forecasts before the war began suggested it would fall to two per cent in the year to April when policies stripping energy subsidies from household bills take effect.
Pantheon Macroeconomics’ rule of thumb analysis on the impact of market prices, which reflects similar calculations conducted by the Treasury, suggests that each 10 per cent rise in oil prices adds around 11 basis points to inflation after around two months.
Interest rate cuts depend on ‘second round effects’
Some economists have suggested that the risks of wage growth surging, which could in turn push inflation higher, have decreased since 2022 given weaknesses in the UK labour market.
Rising unemployment and falling vacancies could lower the chances of workers demanding higher salaries in response to rising prices, thereby minimising the risk of “second-round effects”, as the Bank of England refers to.
Deutsche Bank’s Sanjay Raja said MPC members would need to see more evidence that the risk of such effects would be “muted” over the coming months.
However, ING’s James Smith said that a growing number of MPC members found that the risk of second-round effects was “much diminished compared to 2022”.
He added that the Bank would “play for time” given no press conference was planned on Thursday while future guidance on interest rates would refer to the “evolution of energy prices and the impact on expectations”.
“We suspect the Bank would wait and see how firms react in surveys through the summer, on questions like wage growth expectations,” Smith said.
“That would point to a prolonged pause, but we think we could still see further easing later in the Autumn and into winter.”