“It’s appropriate” that markets price in “a significantly earlier path of tightening than they did previously.”
By Wolf Richter for WOLF STREET.
Inflation in the UK has shot from below 1% earlier this year to 3.2% in August, the highest in 10 years, with core inflation – excluding food and energy – hitting 3.1%. OK, there was some “base effect” due to the very low inflation rate a year earlier. But the current spike of inflation, as measured by the last six-month average inflation annualized, is already at 4.5%, unrelated to the base effect. An annual inflation rate of 4.5% would be the highest in decades. In September, the Bank of England hiked its forecast for annual inflation by the end of the year to over 4%.
While this is still lower than the red-hot inflation in the US, it is way above the Bank of England’s target of 2.0%.
And the BoE is getting worried that the underlying trends are persistent, instead of temporary, that they’re getting embedded in the economy, and that they will be hard to dislodge through monetary policy once they’re embedded, and it’s making rate-hike noises a lot sooner than expected.
“Unfortunately, if you look at our last forecast, it [inflation] is going to go higher, I am afraid,” Andrew Bailey, Governor of the BoE and Chair of the BoE’s Monetary Policy Committee, told the Yorkshire Post in an interview. “As the Bank of England governor, I would prefer it not be there. But we are in very unusual times, and what I would say is we have to manage our way through these times,” he said.
“Obviously I am concerned with inflation above target,” he said. “We are going to have a very delicate and challenging job on our hands, so we have got to, in a sense, prevent the thing becoming permanently embedded because that would obviously be very damaging.”
A huge amount of focus was currently being directed to bring inflation under control, he said.
With the pandemic having altered consumer behavior, the economy had a “whole range of challenges that we are just going to have to deal with,” he said.
“We have got some very big and unwanted price changes,” he said
“This has been an almost unprecedented set of events. They are not over yet, that we are learning. We have to manage our way through them, and we will do that,” he said.
Pricing in the energy market indicated that inflation would be higher next year, as a price cap on consumers’ energy tariffs set by the regulator is expected to rise again next year.
“A huge amount can happen between now and then, so I am not going to speculate,” Bailey said, “but at the moment the forward curve would suggest that it would be higher, so that would suggest inflation persistence.
“So transience would be longer,” he said.
Financial markets are now pricing in the first rate hike later this year, after the BoE, in its last meeting, raised the possibility that it could raise rates as early as November.
Michael Saunders, a member of the BoE’s Monetary Policy Committee, told the Telegraph, “I think it is appropriate that the markets have moved to pricing a significantly earlier path of tightening than they did previously.”
He’s concerned that capacity pressures and higher growth in wages are driving an increase in inflation that “could become more persistent unless monetary policy responds,” he said.
Huw Pill, the BoE’s new chief economist, said last week, the “balance of risks is currently shifting towards great concerns about the inflation outlook, as the current strength of inflation looks set to prove more long-lasting than originally anticipated.”
If the BoE raises its policy rate this year, far earlier than was expected just a couple of months ago, it would follow in the footsteps of smaller central banks in Europe and elsewhere that have already raised their rates, some of them already multiple times:
- Bank of Korea: 1 hike, by 25 basis points
- Czech National Bank: 3 hikes, by a total of 125 basis points
- National Bank of Poland: 1 hike, by 40 basis points
- Central Bank of Iceland: 3 hikes, by a total 75 basis points
- Norges Bank (Norway): 1 hike, by 25 basis points
- Reserve Bank of New Zealand: by 25 basis points.
This has all come a lot faster than expected this spring. And there are increasingly vocal concerns – such as by the BoE governors, but also among Fed governors and many others – that the notion of this inflation surge being “transitory” or “temporary” may not play out in reality.
There are vocal concerns that the underlying tendencies are an indication that this is going to be much more persistent, and is in the process of getting embedded in the economy, amid altered consumer behavior documented by their willingness and ability to pay whatever amid enormous fiscal and monetary stimulus. And tightening – or rather the removal of monetary stimulus, as central bankers will emphasize – is coming faster than previously expected. One of the biggest money printers, the Bank of Japan, has already stopped printing money
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