Bank of England steps closer to a rate hike
Next month’s vote pits the Bank’s doves against its hawks, whose calls for higher rates to tackle inflation are gaining ground
While Covid cases remain stubbornly high, the Bank of England's emergency stimulus – brought in to counter the effects of the pandemic – could start to be reversed in as little as three weeks.
Officials at Threadneedle Street are looking at raising interest rates. Financial markets think there is a 50-50 chance this will happen on November 4.
Sterling leapt to €1.185 on Friday, its highest level against the euro since Covid first erupted on the global stage, as the prospect of higher rates attracts international financiers.
This would represent something of a handbrake turn for an institution which had taken a leading role setting out steady policy and reassuring markets, businesses and households.
Next month’s vote between the nine members of the Monetary Policy Committee (MPC) is finely balanced as hawks come out of hiding to make the case for higher rates to control inflation, while doves – in the ascendency until the past few weeks – defend ultra-low rates as a key prop to the economy.
A move in the coming weeks would mark an end to the emergency policy introduced in March 2020, taking the base rate from its current level of 0.1pc, a record low, back to 0.25pc.
More hikes could follow.
City traders are fully pricing in this first hike for December, with repeated tightening over the next year taking rates as high as 1pc by the end of 2022, a level not seen since 2009.
Bank officials have already indicated that once the base rate rises to 0.5pc, the door could be open to consider running down the stock of bonds bought under quantitative easing (QE), at first by simply not replacing those bonds which mature over time.
Robert Wood, economist at Bank of America, anticipates “quick fire” hikes, raising rates to 0.25pc in December then 0.5pc in February, and beginning to let the total stock of QE bonds shrink from March.
Until this week, he had forecast one hike in February then a second a year later, so his new predictions underline the extent of the U-turn.
This represents a remarkably rapid change of tack for a central bank which had appeared to be on a steady trajectory: end QE on schedule in December at a total of £895bn, very gradually raise rates in 2021 or later, eventually stop maintaining the stock of bonds to reverse the emergency policy.
Until recent weeks, hawks were in such short supply on the MPC that they risked going extinct as a species.
In May and June, only Andy Haldane, the chief economist, voted to curtail QE early, and he has since left the Bank.
His mantle was taken up by Michael Saunders, an external member of the committee, and Sir Dave Ramsden, a deputy Governor.
Even then, their two votes to stop QE were a small minority against the other seven members.
It looked as if any plan to tighten policy was dead.
Then came the supply crises, the petrol panic and inflation surging above 3pc – firmly beyond the Bank’s 2pc target. Price rises are set to rise above 4pc and stay there for some time.
In September’s MPC meeting, policymakers included a highly unusual statement which initially was so confusing to markets and analysts that it received little attention.
It indicated that the seven policymakers who voted to hold policy “agreed that any future initial tightening of monetary policy should be implemented by an increase in Bank Rate, even if that tightening became appropriate before the end of the existing UK government bond asset purchase programme.”
This raised the prospect of the unconventional combination of interest rates going up even as the Bank continues quantitative easing – tightening policy at the same time as the loosening voted for last year is still being implemented.
George Buckley, economist at Nomura, says this points to a chance of a hike very soon: “With the [QE] programme due to end close to the time of the December meeting, we think the MPC’s comments could only be referring to a possible November move.”
Financial markets have taken this possibility to heart, but economists are concerned it could show petrol-panicking drivers are not the only ones overreacting to events.
Kallum Pickering, economist at Berenberg Bank, says the economy has recovered strongly with many current supply problems a function of booming demand, meaning it is right for the Bank of England to look at “normalising” policy.
But he advises against any moves which are too sudden.
“A November or December rate hike would look a bit panicked,” he says, adding that Bank communications have appeared “muddled”.
“November will be an opportunity for the Bank to clarify its guidance and signify whether a rate hike is due in December or February, so that the market will not be surprised.”
Who has said what?
In the hawks’ corner are Saunders, Ramsden and the new chief economist Huw Pill.
“I think it is appropriate that the markets have moved to pricing a significantly earlier path of tightening than they did previously,” Saunders told the Telegraph. He was speaking when markets expected a February rate rise, and had half priced in a December tightening, but investors reacted by anticipating an even quicker hike.
Meanwhile Ramsden last month said he was particularly focused on the risk of higher inflation. Pill last week said “the current strength of inflation looks set to prove more long lasting than originally anticipated” – comments which indicate they are both leaning towards tighter policy.
Most prominent among the doves are Silvana Tenreyro, Jonathan Haskel and newcomer Catherine Mann, all external members of the committee.
Tenreyro expects inflation to be short-lived, suggesting there is little need for a rate rise and warning that acting now risks being “self-defeating”.
Mann said that market expectations have already had the effect of tightening financial conditions, removing the need for the Bank to act.
Up for grabs are the votes of Ben Broadbent and Sir Jon Cunliffe – both Deputy Governors – and Andrew Bailey, the Governor himself.
The first two have remained quiet on the topic.
But Bailey has given succour to those anticipating higher borrowing costs by warning that rising inflation could become embedded, rather than fading as policymakers had previously anticipated.
“We have got to, in a sense, prevent the thing becoming permanently embedded because that would obviously be very damaging,” he said in an interview with the Yorkshire Post last weekend.
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