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MPC’s rates dilemma: protect the recovery or tackle inflation?

·3 min read
<span>Photograph: Jeff J Mitchell/PA</span>
Photograph: Jeff J Mitchell/PA

Economic growth is losing steam and inflation is heading for boiling point. When the Bank of England’s rate-setters meet this week, there will be contrasting warning signs to consider.

With the most severe disruption to company supply chains since the 1970s, the recovery from last winter’s lockdown is practically stalling. Companies are struggling to recruit staff to keep the tills ringing, raw material costs have surged, and energy prices have hit record highs. All of this threatens to feed into higher inflation this autumn, after the consumer prices measure of annual inflation made a record jump in August, to 3.2%.

At the same time, prophecies of a post-lockdown consumer spending boom, made earlier this year, appear wide of the mark, with the coronavirus Delta variant driving up infection rates before a potentially very tough winter.

For many economists there is a whiff of stagflation in the air, reminiscent of the 1970s – the last time the world economy suffered sluggish growth rates in tandem with elevated inflationary pressure.

The end of furlough is looming, along with the cut in universal credit and a planned increase in national insurance

With this the Bank’s policymakers face a dilemma: do conditions warrant an increase in interest rates to tame the inflationary beast, or would an increase in borrowing costs further damage the faltering economic recovery from Covid-19?

Threadneedle Street has so far erred on the side of caution, arguing that the post-lockdown inflationary burst will prove transient. And it does so with good reason. Behind our current soaring inflation lies the natural tale of recovery from a record crash in economic activity in 2020. Rishi Sunak’s eat out to help out scheme slashed the cost of restaurant meals in August 2020, which means a return to relative normality in 2021 fuelled an artificially high inflation rate.

City economists expect the Bank will maintain a cautious stance this week. However, attention will focus on any signals from the monetary policy committee (MPC) about the future timing and pace of tightening measures.

Financial market investors will pay similarly eagle-eyed attention to the US Federal Reserve when its rate-setters meet on Wednesday, in a busy week for global central banks.

Andrew Bailey, the Bank’s governor, let slip last week that at the central bank’s last meeting in August, four members of the MPC felt the conditions had been met for readying the ground for interest-rate rises.

Since then, two new faces have joined the nine-member rate-setting panel: Huw Pill, the former Goldman Sachs economist, who replaced Andy Haldane as the Bank’s chief economist this month; and Catherine Mann, former global chief economist at Citibank.

Analysts expect the majority of them will agree that conditions are right for raising interest rates, although action to raise borrowing costs is still unlikely until at least early next year.

Britain’s economy is at a delicate point, with the end of furlough looming, along with the biggest-ever overnight cut in social security – to universal credit – and an increase in national insurance. All will put pressure on household finances.

Despite falling unemployment and record job vacancies, more than a million jobs are still thought to be on furlough. Economists believe the Bank will want to wait and see how the coming months pan out.

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