The Bank of England’s forecasts for the UK economy have evolved so radically over the past six months that they have sown confusion and forced it to answer questions about its credibility.
(Bloomberg) — The Bank of England’s forecasts for the UK economy have evolved so radically over the past six months that they have sown confusion and forced it to answer questions about its credibility.
Last November, the central bank warned that the UK would fall into recession with interest rates at just 3%. On Thursday, after raising rates to the far more punitive level of 4.5%, the recession vanished from its outlook, and fewer people were expected to lose their jobs.
Governor Andrew Bailey and his colleagues explained the apparent contradiction by pointing to the recent plunge in natural gas prices and the Treasury’s budget stimulus, which are alleviating the worst of a cost-of-living crisis. The growth upgrade was its biggest since independence in 1997.
But Bailey also admitted that the BOE had underestimated Britain’s economic resilience and just how sticky wages, food and domestic prices would be while overestimating the impact of rate rises on unemployment. He spent much of an hour-long briefing defending the BOE’s reputation. Yet economists remained puzzled.
Inflation “somewhat incongruously undershoots the target during the relevant two-to-three year forecast horizon,” said Ross Walker, head of global macroeconomics at NatWest Markets.
The debate leaves the UK economy on track for a bumpy recovery from the pandemic, lagging other Group of Seven nations and complicating the pitch Prime Minister Rishi Sunak’s Conservative Party will take to the general election widely expected next year.
Normally, a big boost for growth forecasts would also increase the outlook for inflation — the the revisions to the outlook for gross domestic product were the largest since at least 1997. Walker said that for now it’s better to ignore the forecasts and focus on the BOE’s line that it’s decisions are “data dependent” because “little weight is attached to medium term forecasts.”
What Bloomberg Economics Says …
“The Bank of England’s decision to leave its policy guidance unchanged in May suggests the central bank is reticent to signal it’s getting closer to pause its hiking cycle. While the strong near-term outlook for annual CPI has reduced the chance of nasty data surprises in coming months, the focus on upside risks as well as scope for wage inflation data to show further signs of persistence leave us comfortable with our expectation for a final hike in June.”
—Dan Hanson and Ana Andrade, Bloomberg Economics. Click for the REACT.
With consumer price growth in the UK at 10.1% — five times the BOE’s 2% target and more than double the rate in the US — Bailey and his colleagues are under intense scrutiny.
Concern about inflation is rising up the political agenda ahead of an election that’s widely expected next year. Both houses of Parliament are conducting inquiries into the bank’s recent track record. And earlier this week, former Federal Reserve Vice Chair Donald Kohn faulted the BOE for a lack of intellectual diversity among its policy makers.
Sunak’s office had to admit on Thursday that his goal of halving inflation this year, which is ultimately the BOE’s responsibility to deliver, may now prove unattainable.
“This is not something that the UK is simply on a glide path to achieve,” Sunak’s spokesman Max Blain told reporters. “It requires discipline and focus.”
By raising interest rates to get a grip on prices, the BOE is now hurting consumers, which could well draw it deeper into politics. This year, 1.3 million homeowners will see their annual mortgage costs rise by an average of £200 ($250.27) a month as they reset to higher rates, the BOE said.
Chancellor Jeremy Hunt said the latest rate hike was “obviously very disappointing for families with mortgages.”
The BOE is holding fast in the face of questions about its monetary framework and forecasting record. Asked by reporters whether he should be apologising for letting inflation get out of control, and for driving up people’s borrowing costs, Bailey said: “We don’t use the language of blame.”
Dave Ramsden, the deputy governor for markets, defended the BOE, saying that investors appeared still to have faith in the institution. “If you look at market-based measures, you get no sense of a challenge to the credibility of the framework,” Ramsden said. “We are not seeing that de-anchoring in medium term inflation expectations.”
The BOE had paved the way for a pause in rates when it changed its guidance in February. Since then, it has raised them a quarter point at two meetings, taking the tally to 12 in a row.
There may be more coming. Its guidance was unchanged despite the two additional rate increases, a decision that George Buckley, European economist at Nomura, said “was revealing.”
Bailey was adamant that there was no “directional steer” on the BOE’s next rate decision. “We will be driven by the evidence at each meeting,” the governor said. “There is no bias.”
Sanjay Raja, chief UK economist at Deutsche Bank Research, said the position meant the BOE is “captive to forthcoming growth, labor market, and inflation data.”
Markets now expect the BOE to stop raising rates at 5%, well above the 3% to 3.5% peak rate that the BOE’s forecasts last November implied. Most economists surveyed before Thursday’s decision expected that today’s hike will be the last for now.
The BOE hopes the data will start making its life easier, as the recent drop in energy prices will automatically pull down the headline rate of inflation when April figures are released later this month.
The consumer price index will be 5.1% at the end of the year, the BOE believes, and 1% in two years’ time.
That poses another set of problems. The bank is flying blind because it believes its transmission mechanism is slower than normal, with more mortgage holders locking in borrowing costs. Just a third of the impact of rate rises has fed through to the economy, it said.
If it’s correct, and inflation does fall as forecast well below the target by 2025, Bailey may well be accused of tightening too much.
–With assistance from Andrew Atkinson.
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