With UK core inflation still in double digits, according to the most recent data, the Bank of England (BoE) took the only course it could and raised the base rate this week to 4.5 per cent. There is little point abandoning the fight against inflation at the point when one more push might finally topple the demon, and holding off runs the risk of allowing it to cement its grip.
But will the rise of 25 basis points signal the end of the tightening battle for the Bank, or could there be more to come? The Bank's own report suggests inflation will tumble as the year progresses, so it's latest move could be its last. Two of the seven committee members did not even support the latest move. In the US the Federal Reserve indicated that its latest rise, last week, is likely to be its final hike and although inflation there is showing signs of weakening, it hasn’t completely ruled out “additional policy firming” as appropriate. Banking turmoil is helping, given its potential to tip the US into recession and cool off the jobs market. Some analysts are even predicting that US rate cuts will happen sooner and be more aggressive than expected.
The European Central Bank is much warier, warning that more hikes will be necessary. The BoE is somewhere in the middle, but echoed the Fed with a warning that surprises to the upside on inflation will almost certainly result in further tightening.
So what is the next step for the BoE? With the next decision on rates not due until late June, if good news on price rises and wages starts coming through, it’s possible that the BoE will press pause and stick with a rate of 4.5 per cent at that point. That would give it more time to assess the absorption of this week’s likely hike on economic activity and household incomes before pushing the rate up again. Not opting for a further rise will give the fragile economy a chance to return to sturdy health – Friday’s GDP numbers are expected to reveal quarter-on-quarter growth of as little as 0.1 per cent.
Supporting a pause in June is the Bank’s own expectation of a sharp fall in the rate of price growth from the middle of this year, in large part because the steep rises in energy prices a year ago will now be falling out of the calculation, bringing down the annual rate of inflation.
But soaring energy costs have not been the sole guilty party. Second-round effects on wages remain a threat and it’s difficult for anyone who shops not to believe in greedflation. However not everyone agrees with the corporate profiteering narrative. Economic consultancy Pantheon says the macro data does not support the profit-led inflation theory, pointing out that the profitability of listed consumer-focused companies has been broadly flat in recent months. And it argues that the fact discounters Aldi and Lidl have increased their market share of UK food sales over the last 12 months disproves the theory that consumers will accept price rises.
While some analysts think the latest rate rise heralds a conclusion to this round of monetary tightening, others aren’t ruling out at least one more rise – ahead of the announcement this week Kallum Pickering at Berenberg put a 30 per cent probability on a final 25 basis point hike at the next meeting in June. Some have not ruled out two more rises to a final base rate level of 5 per cent, because a fall in inflation won’t mean the danger has necessarily passed.
The monetary policy committee (MPC) has made it clear it will be led by the inflation data and the level of certainty it can attach to the direction it’s headed in. We won’t find out what’s happening to UK inflation rates until later this month, although the rate is expected to fall back to around 8 per cent. Further out, Pantheon is forecasting an average rate of CPI inflation of 3.2 per cent in Q4 against a consensus figure of 3.6 per cent and the BoE’s latest forecast of 5.1 per cent.
There’s one final factor, highlighted by Pantheon, that could have a material bearing on the likelihood of base rate cuts next year. If the government decides to cut taxes ahead of the general election any such loosening of fiscal plans would need to be taken into account by the MPC when it mulls how quickly to cut rates.
