Bank of England Wobbles on the Tightrope Between Inflation and Recession

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The Bank of England’s latest meeting has delivered a dovish rate hike that’s fraught with complications. Its Monetary Policy Committee is clearly struggling to navigate a path between the devil of runaway inflation and the deep blue sea of tipping the economy into recession.

Six members voted for the expected quarter-point increase in the official bank rate to 1%, the fourth-consecutive rise, but three wanted a more aggressive half-point hike. Confusingly, two policy makers (who presumably voted with the majority) wanted to drop the bank’s guidance about the prospect of further action in the coming months — producing the awkward consensus statement that ”some degree of further tightening…might still be appropriate.” The outlook is as clear as mud.

For now, sterling markets see the scrambled message as a undermining the central bank’s commitment to battle inflation at all costs. The pound voted most clearly with its feet – heading straight down versus the dollar to the weakest level since the summer of 2020. U.K. government bond yields also fell across the curve.

Three features of Thursday’s decisions are notable. First, although there was a split vote, the MPC did not follow the Federal Reserve in hiking in bigger steps or signaling there’s more action to come. Second, that split makes it is much more likely that little-to-nothing happens fast. Lastly, active selling of the stockpile of government bonds that the bank has accumulated is not imminent.

The MPC’s approach to quantitative tightening by actively selling its gilt holdings back into the market remains cautious. It has kicked that can down the road until its next quarterly review in August, with the proviso that even if it decides to proceed any decision to do so will not be until September. Plans to sell down its entire 20 billion-pound ($24.8 billion) corporate bond portfolio in the next two years won’t start until late in the third quarter. It’s obvious that the BOE is watching how the Fed’s QT plans, announced by the U.S. central bank on Wednesday, fare before committing to balance-sheet reduction while it is still nominally in rate-tightening mode.

The overall impression is one of U.K. dithering. It means a gap has opened up between the more aggressive Fed and the now-vacillating BOE. If the European Central Bank pushes ahead with its first rate hike in July, as looks increasingly likely, then the first-mover advantage the BOE had previously enjoyed by starting rate hikes and shrinking its balance sheet ahead of other major central banks will be lost. That risks weakening the pound even further.

The quarterly revisions to the BOE’s quarterly forecasts have something for everyone. The most eye-catching are upward revisions to the inflation rate. Longer-term, the picture is one of the economy hitting a brick wall with gross domestic product actually turning negative next year, although somehow avoiding a technical recession. This obviously opens up the prospect of stagflation, a concept Governor Andrew Bailey refused to be drawn on at the press conference. 

Annual inflation is already more than triple the central bank’s 2% target rate, steaming in at 7% in March. It now expects the increase in consumer prices to accelerate into double digits, reaching 10.2% in the fourth quarter as wages increase by an average of 5.75% this year and energy prices continue to soar. Moreover, Bailey said that the risks to those projections are “skewed to the upside.” 

There’s a subliminal message buried in the central bank’s forecast that if the official interest rate climbed to the 2.5% level anticipated in the futures market, inflation would slow to 1.3% by 2025 — that the current eye-popping inflation figures won’t last, so don’t expect it to risk a proper recession by over-tightening policy. It clearly doesn’t help that the government is increasing taxes at the same time as the country is suffering a cost-of-living crisis.

However, the BOE’s track record on predicting inflation is so appalling, that’s a hard message to sell.  Thursday’s move may not be the last rate hike in this cycle, but a pause for the next meeting or two is highly likely — and the hurdle for future increases just got higher.

More From Bloomberg Opinion:

• Central Bankers Are Handcuffed by Old Narratives: Clive Crook

• After Half-Point Hike, How High Will the Fed Go?: Jonathan Levin

• The Hideous Strength of the U.S. Dollar: Marcus Ashworth

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Marcus Ashworth is a Bloomberg Opinion columnist covering European markets. He spent three decades in the banking industry, most recently as chief markets strategist at Haitong Securities in London.

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