The Bank of England chose not to follow the leader after the Federal Reserve raised its interest rate to 0.75 percent on Wednesday, but the UK central bank indicated its decision was not the final word on fighting inflation.
Choosing a more modest increase of 0.5 percentage points on Thursday to keep interest rates at 2.25 per cent, the BoE Monetary Policy Committee braced itself for a game of tug of war with the new ministerial team running the Treasury this autumn .
The MPC clarified that the rate hike was an interim decision as it cannot factor in the potential impact of Friday’s mini-budget by new Chancellor Quasi Quarteng, which focuses on plans to kick-start economic growth.
Minutes of the MPC’s September meeting stated: “All members . . . agreed that the forthcoming development plan would provide further financial support and was likely to include news that was critical to the economic outlook.
With major monetary policy decisions postponed until November, the MPC had to strike a delicate balance in its latest meeting.
The economy has weakened since the BoE last published the forecast in August – the MPC now believes it has shrunk for two consecutive quarters. Meanwhile new Prime Minister Liz Truss’s plans to cap energy prices for homes and businesses and through large tax cuts are likely to reduce inflation in the short term, while making it more stable in the latter.
These tensions were reflected in a split vote on interest rates on the nine-member MPC. Five wanted an increase of 0.5 percentage points, while three voted for a more aggressive increase of 0.75 percentage points. One disagreed, demanding a small increase of 0.25 percentage points.
Most economists thought the BoE’s cautious approach, and the protected tone of the MPC minutes, was justified given the difficult timing of its meeting – just a day before Quarteng’s “fiscal event”.
Minutes showed that although Treasury Chief Economist Claire Lombardelli was present at the MPC meeting, she did not brief the committee on the government’s financial plans.
“The MPC seemed careful not to openly criticize fiscal policy,” said Investec economist Eli Henderson, adding the government’s planned fiscal expansion would ultimately “result in higher rates in the long run.”
JPMorgan economist Alan Monks said the MPC vote was “a very close call” with the most recent figures and the decline in growth outlook “played some part in pushing the MPC away from a 0.75 percent increase”.
Julian Jessop, a fellow at the Institute of Economic Affairs, a think-tank, expressed his disappointment at “another missed opportunity [for the BoE] To gain credibility” in fighting inflation.
But he also noted “mitigating factors,” noting that the BoE was moving to sell off some of the government bonds it had accumulated in its quantitative easing programs since 2009. The move was likely to increase government borrowing costs in financial markets.
Economists said markets were reassured by the BoE’s promise that it would give a full assessment of the effects of the government’s pump priming of the economy at the November meeting of the MPC.
Sterling was stable following the latest MPC decision, though near a 37-year low against the dollar, and little change in government borrowing costs. Markets still expect the BoE to forcefully and roughly double interest rates to more than 4 percent by next summer.
Several economists said that the most striking feature of the MPC’s decision was the three-way split in the committee.
Andrew Goodwin at consultancy Oxford Economics said this suggests the MPC is now more likely to vote for a bigger, 0.75 percentage point increase in November, adding: “Only two members have to tilt their balance.” Need to change mind, bar has been kept low for faster growth.” But James Smith at ING drew the opposite conclusion, saying that the growing split on the MPC was “a sign that market expectations are unlikely to be met”.
Ben Nabarro, UK economist at Citi, said the MPC’s November meeting now holds special significance as it will be the committee’s last chance to demonstrate that it will not lend to government borrowing and that tax cuts will keep inflation too high for too long. Will keep
“The minutes make several references to the financial plans of the Prime Minister’s Truce,” he said. “We see this as a warning that further acceleration [in interest rate rises] Might be on the cards yet.”
There has rarely been a direct confrontation between the government and the BoE since it gained independence to set interest rates in 1997.
Since becoming chancellor this month, Quarteng has stressed the need for “coordination” between monetary and fiscal policy in the future, but has not defined what he means by that.
But now the BoE is on a collision course with the government, determined to ensure inflation comes down to the central bank’s 2 per cent target of 9.9 per cent in August and companies and workers believe it Serious.
MUFG Bank economist Henry Cook said the days of alignment between the Treasury and the BoE are over and it is beginning a new tension at the heart of economic policy.
He said, “Unlike in the years following the global financial crisis, it is now the Treasury that is supporting the economy – while policymakers on Threadneedle Street are rushing to tighten policy in an effort to rein in rising inflation, ” They said.