Inflation pressure to test Bank of England’s patience at key meeting, economists warn

Buses pass in the City of London financial district outside the Royal Exchange near the Bank of England on 2nd July 2021 in London, United Kingdom.

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LONDON — Economists broadly expect the Bank of England‘s Monetary Policy Committee to raise its inflation forecasts on Thursday after two straight months of overshoots.

However, investors should not expect a hawkish shift, and economists at several major European banks are expecting the BOE to strike a cautiously optimistic tone while leaving its quantitative easing program and interest rate stance in place.

The U.K.’s consumer price index was up 0.5% month-on-month in June, the latest available reading, well ahead of consensus expectations and representing the highest annual acceleration since May 2018.

The BOE has projected that inflation will peak above 3% by the end of 2021 as the economy rebounds from its historic pandemic-induced decline in 2020. Yet, most policymakers are yet to see sufficient evidence that the inflation overshoots will be anything other than transitory.

“Reopening-related price spikes in various consumer services are combining with lingering supply chain disruption and energy base effects to drive a faster inflation rate than the Bank had pencilled in back in May,” ING developed markets economist James Smith and senior rates strategist Antoine Bouvet predicted Friday.

“We now expect CPI to peak around 3.5% later this year, compared to 2.5% as the Bank was forecasting back in May.”

ING does not expect any wholesale changes to the Bank’s medium-term growth outlook, which sees GDP reaching pre-pandemic levels in the fourth quarter. Smith and Bouvet expect the Bank to scale back its third-quarter growth forecast, however, to between 1.5% and 2%, down from 3.8%.

Daily new cases of Covid-19 in the U.K. have been in steady decline since a recent peak last month due to the surge of the highly transmissible delta variant. However, rising cases around the world and the lagged effect of England’s total easing of containment measures may offer cause for caution with regards to any hawkish pivot. Economic activity took a hit in July as large swathes of the population were instructed to self-isolate due to the surge in cases.

“Ultimately this is [hopefully] going to be a temporary story, but the short-term disruption has effectively pressed pause on the recovery and may have tempered some of the consumer optimism that had emerged through the spring,” they said.

Smith and Bouvet added that the Bank is unlikely to bring forward the end of its quantitative easing program, as advocated for by more hawkish members of the MPC. ING does not expect the first interest rate hike until early 2023, nor any hints regarding future rate hikes on Thursday.

Tested patience

BNP Paribas chief European economist Paul Hollingsworth said the “significant overshoot” of the Bank’s inflation target that is likely to become apparent in the upcoming forecasts will “test the patience” of some MPC members.

“That said, with insufficient evidence to conclude that the pick-up in inflation will be persistent, and rising Covid-19 cases likely to instil some caution, we think only one MPC member will vote for tighter policy now – via scaled-back QE purchases,” Hollingsworth said in a note Friday.

That one MPC member is likely to be well-known hawk Michael Saunders, who has advocated for an early end to the Bank’s asset purchases, echoing the suggestion of former chief economist Andy Haldane. BOE Deputy Governor Dave Ramsden has also struck a more hawkish tone in recent speeches.

As it stands, the BOE is expected to finish expanding its balance sheet at the end of the year.

BNP Paribas still sees the BOE hiking interest rates sooner than other major central banks, forecasting a hike in August 2022 with risks skewed toward earlier tightening of monetary policy.

“Two consecutive months of significantly higher-than-expected inflation [a surprise of 30bp to the BoE’s Q2 forecast] coupled with a spate of recent speeches by the MPC members with a more hawkish tilt has thrown into question whether the process of policy tightening might begin earlier than expected,” Hollingsworth added.

Like its peers, Barclays also expects Thursday’s announcement to set out broad principles while retaining much of the MPC’s “discretionary freedom,” with inflation risks remaining mostly conditional on as yet unavailable data.

This includes employment readouts from after the winding down of the U.K.’s furlough scheme, which will offer a more realistic picture of the country’s labor market.

Barclays chief U.K. economist Fabrice Montagné also expects the MPC to keep policy unchanged, with only Saunders voting to bring forward the end of the current QE program.

“We expect the Bank to boost its short-term forecasts for growth and inflation relative to the May projections, but will likely keep the medium-term outlook little changed [much as in the May forecast round] while muscling up the inflation narrative by highlighting that the Bank stands ready to address any sustained inflation overshoot, aiming at containing inflation expectations,” Montagné said in a research note Thursday.

“The Bank will likely present its latest thoughts on the sequencing of monetary tightening, aiming at broad principles rather than delivering a set of thresholds and rules that would effectively put monetary policy on autopilot.”

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