Bank of England economists in three-way split over rate rises

The Bank of England is certain about one thing: the cost of living crisis must be brought under control.

But the nine-member Monetary Policy Committee (MPC), which is tasked with keeping inflation at 2 percent by raising Britain’s key interest rate, is divided on how to achieve that.

The MPC began its cost-of-living battle almost exactly a year ago, when it began raising base rates from a low of 0.1 percent.

Since then, it has raised rates a further eight times in an unprecedented effort to keep prices in check.

But with inflation at 10.7 percent in November, only a small drop from the October high of 11.1 percent in 41 years, disagreements are beginning to emerge at the Bank. At the meeting this week, three members voted against the majority.

Six, including banking governor Andrew Bailey, chose to raise the base rate by another 0.5 percentage point, bringing it to a 14-year high of 3.5 percent.

But Catherine Mann, an American economist who has been in the MPC since September 2021, wanted a repeat of last month’s massive 0.75 percentage point increase.

On the other side of the scale, Swati Dhingra and Silvana Tenreyro didn’t want to walk anymore.

The gap shows how uncertain Britain’s top economic minds are about whether inflation, which has eroded household incomes and battered corporate finances, has really peaked. Official data this week showed inflation falling from its 41-year peak, but only slightly.

Meanwhile, the labor market is still tight, with unemployment at historically low levels and a high number of job openings.

This carries the risk of what the Bank calls a ‘wage-price spiral’, in which employers offer higher salaries to attract workers, but cause them to spend more, driving up prices.

These concerns were clear in Bailey’s mind when he voted for a 0.5 percentage point increase, even though it will drive up the cost of debt for mortgagees and other borrowers.

But while higher rates should help lower prices by encouraging saving rather than spending, they also weigh on economic activity and can hurt livelihoods if used with too heavy a hand.

Bailey said: ‘The question we get asked most often is, “Why are you doing this now when so many people are already struggling with higher utility and grocery bills?”

We do it because inflation is too high. We think it’s going to come down pretty sharply from the middle of next year, and raising interest rates is the best way to make sure that happens. Low and stable inflation is essential for a healthy economy.’

But not all of his colleagues agreed. Mann was more concerned that wages would continue to rise, causing inflation to rise for longer.

She said that “withdrawing monetary action now would reduce the risk that bank rates would have to rise well into the next year, even as the economy slowed further.”

However, Dhingra and Tenreyro, both professors at the London School of Economics, are concerned that the full force of the Bank’s record run of increases has not yet been felt.

Real incomes — or wages taking into account the cost of living — are falling, they noted.

And banks, troubled by the slowing economy, are starting to cut back on lending, making it harder for businesses to get loans. “There were growing signs that the downturn was beginning to affect the labor market,” Dhingra and Tenreyro said, according to the minutes of the MPC meeting.

“But the delays in the effects of monetary policy meant that the significant effects of past rate hikes had yet to materialize. That implied that the current bank rate setting was more than enough to get inflation back on target.”

The minutes concluded that future increases were likely: “Further increases in bank rates may be necessary to bring inflation back to target sustainably.”

Just prior to the MPC announcement yesterday, traders had priced in a mid-2023 peak of just over 4.5 percent.

But they were surprised at the “mixed messages.” The pound fell 1.7 percent against the dollar to $1,221 as many assumed the gains would soon dry up.

Matthew Ryan, of payments firm Ebury, said: “The Bank of England continues to send confused messages to markets, with the three-way vote providing little clarity on its rate plans in 2023.

“This is unlikely to inspire much confidence in UK assets, and we suspect the pound could underperform in the near term as a result.”

More walks ahead in the Eurozone

For the long term: ECB President Christine Lagarde

The European Central Bank (ECB) has long promised to raise interest rates ‘at a steady pace’.

When it raised its key interest rate from 1.5 percent to 2 percent and opted for a 0.5 percentage point hike like the Bank of England and the US Federal Reserve did this week, it said rates need to be higher to “guard against the risk of a continued upward shift in inflation expectations’, and to ‘dampen demand’.

Salomon Fiedler, an economist at Berenberg, said the ECB seemed concerned that it was “somewhat off track” to bring inflation back to its target of 2 percent.

In 2022, it now thinks inflation in the Eurozone will reach 8.4 percent, compared to September’s 8.1 percent.

Expectations for 2023 and 2024 were revised upwards and even by 2025 inflation will reach 2.3 percent.

ECB President Christine Lagarde said: “We can expect to raise interest rates by 50 basis points over a period of time.

“We’ve got more ground to cover, we’ve got longer to go and we’re in for a long game.”