The MPC should now pause for breath

The Bank of England’s Monetary Policy Committee (MPC) increased UK interest rates by another half point this week, as most had expected, taking them to 4%. But it also hinted that rates may not rise much further – if at all. I think the MPC has got this about right.

The decision to raise interest rates was still controversial. Indeed, two of the nine MPC members (Swati Dhingra and Silvana Tenreyro) voted for ‘no change’ this week.

Many argue that the current surge in UK inflation (to 10.5% in December) is largely caused by external factors outside the Bank’s control, notably the fallout from the war in Ukraine on global food and energy prices. Higher interest rates could simply add to the pain.

However, ‘core’ inflation – excluding food and energy – is now over 6%. This can no longer be dismissed as ‘largely imported’. A shallow recession of the kind that the Bank is now predicting would be less harmful in the long run than the problems caused by an extended period of very high inflation.

In my view, another hike was also needed to emphasise that the MPC is serious about getting inflation back close to its 2% target within a reasonable period of time. The Bank still expects annual CPI inflation to be around 4% towards the end of this year, so some might say that rates are still too low.

Nonetheless, it will be increasingly hard to make a case for further interest rate hikes from here. This holds whether you focus on monetary conditions, demand-pull and cost-push pressures, or inflation expectations.

In particular, the flood of cheap money that helped to fuel inflation has now turned into a trickle (broad money growth has collapsed from a peak of over 15% in early 2021 to less than 3%). The real economy has already slowed sharply. Global commodity prices are now falling, including food and energy. Supply chain problems are easing. And expectations for inflation have cooled.

The MPC now seems to be thinking along these lines too. The statement accompanying this week’s announcement implied a bias towards further rate increases, but only if there is evidence of ‘more persistent inflationary pressures’. The Bank’s own Chief Economist, Huw Pill, then rammed this message home in a Times Radio interview.

The MPC also made several references to the fact that interest rates have already been raised significantly, and that it will take time for the full effects of these past increases to come through, especially in mortgage costs.

Here, I’m relieved that the MPC has not offered any convoluted ‘forward guidance’ on where rates might be heading. The Bank’s communications can be dire, no-one really knows what’s coming, and it should be up to individual MPC members to make their own calls at each meeting anyway.

Instead, it simply flagged up the tightness of labour market conditions, and the behaviour of wage growth and services inflation.

This suggests that further signs of a slowdown in the labour market, including moderate pay increases, will now keep interest rates on hold.

Perhaps significantly, the Bank’s latest Decision Maker Panel (DMP) survey (taken between 6th and 20th January) was quite dovish (or at least less hawkish), noting a slight decline in inflation expectations, a slowdown in expected wage growth, and an easing of recruitment difficulties.

Of course, there are still huge uncertainties – in both directions. It is touch and go whether the picture will be much clearer by the time of the next MPC meeting, which concludes on 22nd March. But my vote at least would be to pause interest rates at the new level of 4% and to keep them there for the foreseeable future.

Or put another way, ‘four and done’.

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