BoE takes a newly pessimistic view of the economy

As members of the Bank of England’s Monetary Policy Committee debated another interest rate hike on Thursday, there were two new issues to tackle.

Nine MPC members, including BoE governor Andrew Bailey, had to take note of the good news of a sharp fall in wholesale energy prices, and then fit this into the committee’s newly gloomy view of the economy’s ability UK growth without generating inflation.

The result was rather messy. Although the BoE’s new forecasts showed inflation falling well below the central bank’s 2 percent target by next year, MPC members voted by a seven-to-two majority to raise interest rates from 3.5 percent to 4 percent.

At a news conference, senior BoE officials justified the move as being like buying insurance against future price rises – in case the inflation forecasts were wrong. Consumer price inflation was 10.5 percent in December, down from a peak of 11.1 percent in October.

“It is too early to declare victory [over inflation] still,” Bailey said. “We need to be sure that we are really turning the corner on inflation.”

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A majority of MPC members said in the minutes that they placed more emphasis on strong wage and employment data and “much less [weight] on the medium-term projections” for inflation.

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They also said that a desire to make sure they beat inflation could lead to further rate hikes.

Sir Dave Ramsden, BoE deputy governor, said the MPC had to “use [the central bank forecasts] in a more nuanced way than we did in the first 10 years of the MPC”.

But the forecasts suggested that MPC members will not necessarily raise interest rates at their meeting in February.

Whether the MPC looked at the mean, median or mean of forecasts, interest rates of 4 per cent left inflation too low in two years, and far too low in three years, with 50 per cent at least. it may be less than 1 percent.

George Buckley, chief UK economist at Nomura, said: “The banks’ final view on inflation [in 2026] still very weak”.

The underlying message from the BoE’s inflation forecasts was therefore that, if they turned out to be correct, interest rates could soon be falling rapidly.

Bailey confirmed this in a roundabout way, saying: “If the economy changes as in the central case [of the forecasts]we will set a policy accordingly.”

But if the outlook for inflation was good, BoE growth forecasts were bad.

The IMF sent shockwaves across the Atlantic on Tuesday with a forecast that the British economy would slide into recession this year – and become the only industrialized country to do so.

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The BoE was not much different. Its forecast was slightly worse than the IMF’s for 2023, with UK gross domestic product falling by 0.7 per cent in the fourth quarter compared to a year earlier. The BoE was also gloomy about 2024, with the central bank predicting stagnation, and the fund expects growth of 1.8 percent.

Yael Selfin, an economist at KPMG, said the BoE’s short-term growth forecasts would make difficult reading for Britons. “The central bank paints a bleaker picture for the UK economy, which is suffering from a stronger headwind compared to its peers”, she said.

The BoE now expects a shorter and shallower recession than MPC members did at their November meeting, but the fine data shows that GDP is not expected to reach pre-Covid levels until 2026.

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Ben Broadbent, another BoE deputy governor, said the IMF was probably right to say that the UK had the weakest economic prospects among industrialized countries this year, although he added that the differences were small .

He cited unique problems facing the UK in the short term, including declining participation in the labor market, particularly among older people. He also highlighted the UK’s higher dependence on natural gas compared to elsewhere in Europe, which would continue to lower British household incomes, and a faster transition from higher interest rates to more expensive mortgages, which would reduce consumer spending. .

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“These are not things that last forever,” said Broadbent, trying to be positive about the prospects.

But the BoE’s long-term outlook was bleak. Underpinning the MPC members’ view was a new idea that the UK can no longer sustain a growth rate of 1 per cent a year without generating inflation. Previously, they thought that annual growth of 1.5 percent would not generate inflation.

BoE officials did not try to play down the difficulties of surviving in an economy that used to grow at an annual rate of 2.5 percent before the financial crisis, and one that could sustain around 1.7 percent before the coronavirus.

Growth in UK potential supply column chart (% p.a.) showing supply hit by Brexit, Covid and cost of living crisis

Bailey blamed “the change in the trading relationship with the EU”, as well as effects from the pandemic and higher energy prices following Russia’s invasion of Ukraine, which had depressed the UK’s productivity growth and reduced the size of the workforce.

The BoE recognizes that, with few engines of growth, conditions in the UK will be difficult for households and companies, even if the central bank is able to reduce interest rates soon.

James Smith, director of research at the Resolution Foundation, a think tank, said: “Families are living through a two-year downturn in living standards, and Britain is living through 20 years of growth stagnation – the worst since the decades between war. “


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