Daily Management Review

The Bank Of England Will Maintain Interest Rates Even If Inflation Exceeds Its Objective Of 2%


The Bank Of England Will Maintain Interest Rates Even If Inflation Exceeds Its Objective Of 2%
For the first time in over three years, headline inflation in the United Kingdom reached the Bank of England's objective of 2% on Wednesday morning.
However, the report did little more than bolster traders' doubts about the imminence of an interest rate decrease.
After registering higher chances earlier in the week, money market pricing around 11 a.m. in London indicated barely a 5% chance of a Bank Rate decrease during Thursday's BOE meeting. Additionally, wagers on an August reduction were reduced to about 30%.
The 2% inflation rate was expected for some time and was mostly caused by the dramatic year-over-year decrease in energy costs. Nevertheless, it remains a noteworthy milestone, especially as British politicians put up their stalls ahead of a general election in less than two weeks. It is anticipated that the pace will fluctuate in the upcoming months as the energy drag decreases.
Policymakers are also paying close attention to services inflation, which is crucial to comprehending domestic pricing pressures in the nation's services-oriented economy. Services inflation came in at 5.7%, above the 5.5% predicted by experts in a Reuters poll.
When energy, food, drink, and tobacco are taken out of the equation, core inflation stays significantly higher than the long-term average of the central bank, which is 3.5%.
“We’ve seen some good stuff in terms of seasonality, food prices are coming down as well,” James Sproule, chief economist at Handelsbanken, said.
“But looking over the rest of the year, even the Bank of England itself is expecting inflation to start to creep up a bit again over the course of the autumn,” he said.
“I think the most disturbing thing lots of economists like myself are looking at right now is what’s happening in services inflation. That’s largely about people’s salaries and earnings. And those numbers have been proving a good deal stickier than we would like,” Sproule said, with the BOE targeting services inflation of around 3%.
It's still unclear if the BOE will lower interest rates in August or September, he continued.
The BOE reported that average salary growth in the UK, excluding bonuses, remained uncomfortably high in June at 6%, despite indications of a tightening labour market.
The central bank stated at its most recent meeting in May that while recent inflation readings had been "encouraging," the possibility of a rate drop will be evaluated at each meeting and in light of the most recent statistics.
Due to the impending national referendum, members of the BOE's Monetary Policy Committee, including Governor Andrew Bailey, will be more silent than normal on Thursday.
The institution has stated that, regardless of an election, it would be prepared to implement a rate cut if it thought one was necessary. It is politically independent.
However, the economic performance of the United Kingdom has been key to the programmes of both the ruling Conservative Party and its primary opposition, Labour, so central bank action—or lack thereof—will be constantly monitored.
At the May meeting, two MPC members voted to lower rates, while seven voted to maintain them.
The ING economist for developed markets, James Smith, anticipates a recurrence of that divergence on Thursday.
It could be hard to reconcile it with the notion that the committee is on the verge of reducing rates. An August rate cut would still be very much on the table, according to Smith's statement on Tuesday. "But the important thing to remember is that the five internal committee members, who hold the key to the first cut, tend to move as a pack," Smith said.
After the European Central Bank started reducing rates at its June meeting, the BOE decided to keep rates. Although the core rate of inflation in the euro zone has continued to decline, headline inflation in May was 2.6%, higher than in the United Kingdom.
According to Smith of ING, economists will be watching for any indications that the Bank's confidence has been eroded by the most recent statistics, as well as any messages from the BOE on liquidity circumstances and how they affect the economy.
“But listening to Governor Andrew Bailey back in May, it sounded like he was keen to get on with the job of cutting interest rates. And a bit like the European Central Bank, the BOE seems more confident in its inflation predictions than it had been over the past couple of years,” he added.