Since the start of this year, the Bank of England has underestimated the rise in inflation. As late as May, he thought the annual inflation rate could peak at 2.5% by the end of 2021, averaging 1.9% in the third quarter.
Wednesday’s data, showing inflation hit 3.2 percent in August and is expected to exceed 4 percent by year-end, will require a quick review from the BoE.
He must define a monetary policy to facilitate as much as possible the economic recovery from the coronavirus without allowing inflation to take root in wage demands and price increases.
Financial markets expect the first interest rate hike to come in the first quarter of 2022. Ahead of its meeting next week, these are the big five questions facing the BoE.
1. How temporary are the price increases in the UK?
The fear of every central banker is that higher inflation seems trivial at first before becoming dangerously difficult to control. Andy Haldane, the now deceased chief economist of the BoE, warned in June that “time and time again” in the past “localized price pressures have turned into widespread price pressures and these spikes temporary prices turned into more persistent price increases ”.
Many economists have pointed out that the 18.3% annual rise in used car prices reflects a global semiconductor shortage; a significant portion of the rise in the inflation rate in August was caused by falling restaurant prices last year in the “eat out to help” craze; and oil prices are unlikely to continue to rise indefinitely.
But with wholesale gas and electricity prices hitting record highs, energy prices will rise further, so inflation is likely to be more rigid at high levels. Allan Monks, UK economist at JPMorgan, said it was important to recognize that “price dynamics continue to surprise” and that this will keep inflation higher in 2022 longer. He doesn’t expect it to fall below 3% until October 2022.
2. How strong will spending be in the coming months?
The BoE believes that the underlying forces governing inflation are related to the level of spending in the economy and the ability of providers of goods and services to meet this spending.
The good news here for the BoE is bad news for the recovery, which stagnated in July as the Delta variant of the coronavirus hit the UK. The Monetary Policy Committee will have to judge whether this is a temporary shock or more permanent.
Andrew Bailey, governor of the BoE, is satisfied that the recovery is not accelerating uncontrollably. “We are seeing stabilization,” he told MPs this month, suggesting that would reduce concerns about inflation.
The MPC will need to reassess at its meeting next week as the latest data is a bit more solid. Marchel Alexandrovich, European economist at Jefferies, the investment bank, said on Wednesday that his latest assessment of real-time data showed economic activity was below 1% of pre-pandemic levels.
“Another material increase of [traffic] brought the title closer to a full takeover, with continued support from the hiring activity also noticeable, ”said Alexandrovich.
3. How serious and persistent are the supply bottlenecks?
If spending is one side of the coin, the other is the ability of the economy to provide goods and services to meet demand without rising prices.
Empty shelves, rotting fruit in the fields and desperately short-staffed care homes have highlighted the potential for the supply of workers and skills not to match demand well in the coming months, leading to the possibility of more widespread wage and price increases, even with the holiday scheme ending this month.
Semiconductor shortages, which are sapping output in the automotive sector, are unlikely to be resolved soon, and producer price inflation in the UK hit 5.9% in August.
Kallum Pickering, British economist at Berenberg Bank, said these “supply pressures are intensifying and could last until next year”.
Bailey appears to agree, telling MPs he was concerned the current difficulties in matching people to jobs persist.
4. Will low unemployment lead to wage increases?
The BoE is not concerned about higher wages if these were offset by more goods and services offered. But he’s worried about inflation if companies have to raise prices just to pay more to attract employees.
The latest labor market indicators showed vacancies are at record highs and employment has reached pre-pandemic levels. There are still over a million people on leave and former self-employed workers to cut wages, but the Office for National Statistics this month estimated the underlying annual wage growth to be between $ 3. 6% and 5.1%.
Rather unnecessary for the BoE, the lower and upper ends of this range cover the difference between wage growth that is not of concern and something that needs special attention.
Martin Beck, senior advisor to the EY Item Club, said the outlook was still relatively good from an inflation perspective. “An increase in the supply of workers, after the leave, could ease wage pressures,” he said. “And the economic literature suggests that much of next April’s hike in national employers’ insurance will ultimately be passed on to workers through lower wages.”
5. Will the BoE always be trustworthy to control inflation?
Financial market inflation expectations in three years have risen 0.23 percentage points since the last MPC meeting to stand at 3.75% for the retail price index inflation measure , a level that would suggest some lack of confidence in the BoE reaching its 2 percent target of cent on the consumer price measure.
Citi’s regular survey of household inflation expectations showed that households expected prices to rise 3.5% annually over the next five to 10 years, up 0.4 percentage points. percentage since March.
None of this is conclusive evidence that the public is losing faith in the BoE to control inflation, but the numbers will reduce comfort levels on Threadneedle Street.
Janine Boshoff, economist at the National Institute for Economic and Social Research, said: “As headline inflation will remain above the Bank of England’s 2% target in the near term, future communications from the bank around. . .[interest]the normalization of rates will be crucial to prevent a possible dislodgement of inflation expectations.