Increasing energy prices, rampant inflation, worries about a decelerating economy and debate about ‘levelling up’ made a fascinating and complex backcloth to the meeting of the Bank of England’s Monetary Policy Committee last Thursday. This all added to the importance of the Committee’s decision on interest rates and, equally, the messages set out in the minutes of the MPC meeting and statements from the Bank’s Governor and his colleagues.
In brief the Bank appears very concerned about the need for higher interest rates, to return inflation towards the two per cent target, alongside the prospect of economic deceleration and an expected pick up in unemployment.
The previous day Michael Gove had unveiled his long-awaited White Paper on ‘levelling up’ – for England. There was no new money (surprise, surprise) but some indication as to where priority would (or perhaps should) be focused for the deployment of existing, limited, funds. This White Paper followed hard on the heels of confirmation, by PM and Chancellor in tandem, that the increase in National Insurance payments would be implemented in April. The impact of this tax hike, justified by the need for more funds for the NHS and social care, will fall hardest of the lower income groups – many in the areas prioritised for support by Mr Gove. The needs of the NHS and social care are apparent to all, but there are certainly less regressive means of generating those funds.
Taking the NI hike and the White paper together, the net contribution to ‘levelling up’ seems likely to be minimal. First time Tory voters in the ‘red wall’ constituencies may be regretting their actions; and their MPs may be even more concerned about both their party’s policies and their own political futures.
On the self-same morning as the MPC met came the announcement of a massive 54% increase in the cap on energy prices, across the UK, from this April. There were some relatively minor measures announced to partially defer the impact of higher prices. But these relief measures will be dwarfed by the combined impact of the NI hike and the huge increase inked in for gas and electricity prices.
The NI hike and energy price rises will also significantly dampen consumption across the board, given the sharp reduction in disposable income that will ensue.
That will in turn decelerate GDP growth. Also higher energy prices will add to costs of production across broad swathes of our economy, ratcheting up inflation once more.
Of even greater concern to the MPC is the potential impact on wage inflation, if those suffering from cuts in disposable income press for some compensation via higher increases in pay. This pay pressure will come at a time when vacancies are low and the leverage of employees consequently relatively high.
In other words, as the MPC met, they will have seen the risks of events out in the real economy tending to both slow growth and add further stimulus to inflation. Bad news all round, especially as the route to a deceleration in wage inflation would have to be via increasing unemployment.
The MPC has a primary focus on inflation data and expectations. The bad news is that the Consumer Price Index rose to 5.4% in the year ended last December, its highest level for 30 years. In 2021 higher prices were faced to a broadly similar extent by the highest income households (up 5.5%) and those on lowest incomes (up 5.3%). But the impact of the energy price increases will be felt disproportionally by the lower income groups, as energy costs constitute a far higher share of their expenditure than is the case for the more affluent.
The majority of analysts predicted another small interest rise last week. It was therefore no surprise when, albeit by a majority of only 5-4, the MPC voted to raise rates form 0.25% to 0.5%. What was a touch surprising was that the four voters in the minority actually sought a full ½% increase in rates to 0.75%. The fact that the committee was in hawkish mood was confirmed by their decisions to tighten other elements of monetary policy, including reducing their purchasing of Government bonds and their stock of investment-grade corporate bonds. They are really concerned about inflation.
Together these facts signal an end to the era of loose monetary policy and a confirmation of the move back towards ‘normality’. The MPC minutes reveal that inflation is expected to hit 6% over the coming two months, then peaking at over 7% in April. This is some 2 percentage points higher than forecast in the Committee’s November report.
While the CPI is forecast to decline to ‘a little over the 2% target in two years’ time’, there must be significant up-side risks from the combined effect of energy prices and wage inflation. The Committee minutes refer to an expectation of ‘some modest further tightening’ in ‘the coming months’. This may prove to be a distinct under-estimate of what is required to work towards that 2% target.
So monetary policy is tightening; what of fiscal policy? The confirmation of the (unpopular with voters and many Tory MPs) NI increase shows that times are tough on that front as well. Latest data suggest that the deficit in the last financial year was £322 billion, 15% of GDP and more than twice the previous all-time record. Public sector debt at the end of last year reached 96% of GDP, the highest since the dark days of the early 1960s.
So while Government borrowing this year is somewhat below Budget expectations that will not be seen as justification for significant additional spending.
Already the MPC is telling us that ‘UK GDP growth is expected to slow to subdued rates’ in the near term. With monetary policy tightening, no scope for further fiscal laxity, the global economy decelerating and ‘subdued’ growth expected in the UK it sound like time for a large dram.
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