Silvana Tenreiro warns that the Monetary Policy Committee may find that inflation is slow to respond to sustained increases in interest rates. Photo: Elisabeth Frantz/Reuters
Decrease in inflation stalled in May, holding stubbornly at its April level of 8.7%, well above its 2% target.
Turning the tap further and faster, the Bank raised interest rates another 0.5 percentage points. up 5% last week in a desperate attempt to rein in prices.
Tenreyro did not support this move. At her last meeting as a member of the MPC, she voted with Swati Dhingra to keep rates at 4.5 percent.
So we're on the hot side? Or are the other seven members of the MPC, including Andrew Bailey, the governor, correct that the only way to quell inflation is to keep raising the base rate?
The answer is not clear. After all, it's easy to see why Bailey is so worried.
Inflation has declined painfully slowly from its peak of 11.1%. Wage growth is accelerating. And price increases have shifted from goods to services that tend to be more domestically supplied, indicating that global inflation has infected the local economy.
Most believe that high interest rates are necessary to suppress inflation rates. enough to drive demand out of the economy, and frightening enough to show that the Bank is in business to keep workers and bosses from raising wages and prices ahead of time in anticipation of rising costs.
As Bailey said last week after the raise vote: “If we don't raise rates now, it could be worse later. We are striving to bring inflation back to the target level of 2% and will make the necessary decisions to achieve this.”
1406 how the bank made a mistake
This all sounds reasonable, if painful. Bailey's determination to fight inflation means Goldman Sachs economists now expect the MPC to rise to 5.5% at the August meeting and then to 5.75% in September.
However, not everyone agrees that this would be the right move. Tenreiro and Dingra said no more rate hikes were needed.
That's a more difficult argument, given the obvious pressures of remarkably stubborn inflation. But there were two points the couple pulled out, as the minutes of the MPC meeting show.
First, they said that the inflation data shows what has happened over the past year, not what will happen. The energy shock is still weighing on key numbers even as markets have reversed with gasoline prices already falling and household bills soon to follow. Forward-looking indicators also point to declining demand for wages.
Second, it takes time for higher interest rates to feed inflation. The typical assumption is that the full effect is felt only after 18–24 months. The MPC has been raising rates steadily for 18 months, so there's still a lot of tightening to be done in the CPI.
There's strong evidence they might be right.
2,306 boe interest rate
“The bank sets rates based on past data – they should look ahead and think what we think inflation will be in 18 months?” says Martin Beck, chief economic adviser at the EY Item Club.
If you're worried about month-to-month data, that means “they're constantly subject to erratic fluctuations in inflation and wages,” Beck says. “That's where the risk of over-tightening comes in when they use the rearview mirror.”
Producer price inflation, which tracks goods and materials bought and sold by manufacturers, is falling sharply, he says. , indicating a reduction in price pressure in the development process.
Beck believes next month's cut in household energy price ceilings will be a key moment when families should begin to feel the pressure to ease. Even factors such as high immigration should help limit price increases by reducing labor shortages.
2306 ppi and cpi
George Buckley, economist at Nomura, adds that the economy has changed so dramatically over the past 30 years that it is now “fully geared to dealing with interest rates at very low levels.”
Central to this is the mortgage market, where much of the pain of higher rates will be felt.
Ten years ago, most mortgages were issued with floating rates. Now, nearly nine out of every 10 are fixed, so the effect of a rate hike won't be noticed right away.
do more [rate hikes] now?” Buckley says.
In his opinion, everything could be exactly the opposite. “If it's all baked into a pie and it's all going to happen at some point, but we just don't see it because of the longer debt maturities, you can argue the same as Tenreiro.” He says that one might object that “it may be a fool at heart, taking too long.”
1605 Short-term mortgage
Money supply is a less ambiguous factor.
Several economists who track this unfashionable measure, allege that the Bank overdid QE during the pandemic, fueling inflation, and now, in turn, risks overdoing it by raising rates.
Simon Ward, economist at Janus Henderson, says the Bank has “already gone too far.”
“I would characterize this decision [to raise rates to 5%] as the equal and opposite mistake of their decision to expand quantitative easing yet in November 2020,” he says, predicting that inflation will eventually fall below the Bank’s target of 2 percent.
“We were probably already entering a recession in the second half of the year. This will mean that it is deeper and longer. This will mean that inflation will fall even faster.”
Judging who is right is far from easy. Former politicians tend to think that their MPC successors are doing the right thing.
Adam Posen, who served on the committee during the financial crisis, says that “if they had gone too far, we would have seen it in wages already.” , employment and core inflation”. “There will be damage, but it is necessary.”
Willem Buiter, co-founder of the MPC from 1997 to 2000, says interest rates should remain high “until at least the second half of 2024 to dampen aggregate demand enough,” which he suspects will lead to a recession.
Expected economic hit
“The MPC will realize they've gone too far if inflation drops sharply and appears to miss its target,” which he describes as “possible but unlikely.”
Michael Saunders, the hawk who left MPC last year, is confident that the Bank has chosen the best option available.
“Returning to 2% inflation will be painful, but ultimately will be even more painful if MPC will fail. toughen enough,” he says.
Saunders says it is better to err by tightening too quickly than to clean up by cutting interest rates again later—even if that means a short scalding period.
“It’s less risky to tighten too much and then loosen if inflation is likely to be lower than to tighten too little and risk high inflation expectations taking root,” he says.< /p>
Recent Comments