Thursday afternoon was the time when the Bank of England became really firm with the British public.
To return inflation from the expected 7.25% peak in April to the central bank’s 2% target, the BoE has announced action that will hurt most households at the worst possible time.
Members of the BoE’s monetary policy committee voted five to four in favor of raising official interest rates from 0.25% to 0.5%, with the minority demanding a more than half point increase.
This came shortly after the regulator Ofgem said that the ceiling on energy prices, affecting about 22 million households, would rise by 54 percent to an average of £ 1971 a year from April.
The move revealed how the British are struggling with the cost of living crisis, in which rising energy prices brought consumer price inflation to a 30-year high of 5.4% in December.
The BoE has also announced that it has begun quantitatively tightening inventories of the £ 895 billion in assets it has bought to boost the economy following the financial crisis. Initially, the BoE will no longer reinvest the government bond proceeds it holds when they fall, reducing the total by £ 70 billion over the next two years.
Andrew Bailey, the governor of the BoE, made it clear that this was not the end of a heavy love for the British public, saying he felt he had to give a “firm message”.
“We are facing a shrinking real income. . . and we need to raise interest rates because if we don’t, the effects will be even worse, “Bailey said.
He added that there are likely to be more “modest” increases in interest rates in the coming months, as MPC forecasts show that inflation will remain above 2 percent over the next three years if left at 0.5 percent.
Since November, the commission has been alarmed by how much it fails to anticipate rising inflation and the spread of upward pressure on energy prices.
Most worrying for BoE was information from its regional agents showing that companies expect wage settlement to increase to 4.8% in 2022 amid a hot labor market, while a central bank survey found that companies say that they will raise prices by a similar amount.
Financial market expectations for inflation in the medium term are just as high.
Tighter monetary policy to address this concern about high inflation would have many effects, according to BoE officials.
Bailey said part of the way higher interest rates would work is to make loans more expensive and life harder for households, but he also wants to send a message to companies as well as consumers that should expect inflation to fall to 2 percent.
If the business does not do so and continues to raise prices by about 5 percent or more, Bailey’s weakly veiled warning was that he would play even harder to curb inflation.
The effects, he stressed, will not be pleasant. Inflation will be higher, economic growth will be lower, incomes will fall and unemployment will rise.
In its forecasts, the MPC showed that the UK economy will grow by 1.8% next year before slowing to an anemic average of 1% over the next two years, with the unemployment rate rising from a low of 3.8% to 5%. %.
These forecasts were significantly worse than in November, reflecting the 2% reduction that BoE expects on real household disposable incomes in 2022, as wages and benefits fail to keep pace with rising prices.
Economists and financial market traders almost universally took the view that the BoE was very hawkish, especially after the MPC vote, which almost included raising interest rates by half a percentage point. This has not happened since the central bank gained operational independence to set monetary policy in 1997.
Alan Monks, an economist at JPMorgan, said there were “some significant hawks surprises in [the BoE’s] communications ”, as a hint that the next increase in interest rates may be in March.
Stefan Ball, an economist at Goldman Sachs, said the BoE language is in line with two more interest rate hikes over the next three months, bringing them to 1% by May.
But Bailey wanted to emphasize that his message is not that the BoE has become an inflation-fighting warrior seeking to increase the cost of the loan, no matter what.
He has repeatedly cited MPC forecasts that inflation will fall below the central bank’s 2 percent target in three years if interest rates follow market expectations and rise to 1.4 percent.
“Please don’t get carried away,” he urged reporters looking at the forecasts. “There is a downside to this forecast, which will ultimately lead to less action than some observers think.
But the governor’s comments contained a double-edged sword. If energy prices fall, giving households some rest, the implicit warning was that this is likely to create too much growth and an even hotter labor market, so the BoE may still need to raise interest rates in these circumstances.
BoE has not had to play a bad cop in the last 15 years at low interest rates.
The central bank did not like the announcement on Thursday, but Bailey was clear that the United Kingdom would be even worse off if the Bank of England did not limit what is now a serious inflation problem that has happened to it.