Borrowers may face bigger interest rate rises

Its chief economist Huw Pill said he was willing to adopt a “faster pace” of monetary policy tightening than it has implemented since December, which has seen it increase rates by 0.25% in each of the past five meetings. 

The BoE is also set to publish guidance on how it will wind down its asset holdings in August - as part of wider plans to withdraw stimulus and cool the economy. 

It comes as inflation hit a 40-year high of 9.1% in the year to May - with this set to peak at more than eleven percent in October when - according to BoE forecasts - energy bills rise again. 

In a speech made at the global banking and finance conference hosted by King’s’ business school yesterday (6 June), Pill said it’s “essential” to bring inflation back down to the two percent set by the BoE’s Monetary Policy Committee (MPC) in order to “reduce the uncertainties” facing household and allow firms to plan for the future. 

Throughout his speech, Pill highlighted the myriad of issues that have caused the record increases in inflation, including Russia’s invasion of Ukraine as well as the Covid-19 pandemic and its aftermath - describing these as a “sequence of adverse external shock”. 

He also explained the “four features” of these disturbances. First these were “genuine shocks” in a specific, technical sense. 

These shocks have also transmitted into UK inflation relatively quickly, they’ve been large and finally - since the UK is a net importer of goods and energy - these large rises in international goods and energy prices represent a deterioration in the UK terms of trade. 

He added: “Simply put, the goods the UK buys from the rest of the world have become more expensive relative to the services it sells. Other things equal, this will weigh on the international purchasing power of UK residents. 

“In practice, we anticipate a squeeze on UK household real incomes, which constrains domestic spending and demand, and threatens to open up a margin of economic slack and eventually higher unemployment in the UK. So it is not just UK inflation that is affected by the large external price shocks, but UK incomes, spending and employment too.” 

In addition to this, Pill discussed recent MPC communication - most notably the statement published in the aftermath of the June meeting - which he said presented “peeling yet another layer of the onion”. 

He added: “In both the media and among market participants, there is a cottage industry seeking to interpret central bank statements. I have been part of that industry in the past. 

“Those still working there needn’t worry: I am not about to put them out of business, and I am certainly not going to pre-announce my MPC vote today.

“Of course, there will always be efforts to interpret any central bank communication for clues about the policy outlook. That is both inevitable, and sought after by policy makers: after all, what would be the point of making statements if you hope that they will be ignored?

“But I would caution the addressees of such statements against reading them solely through the lens of ‘forward guidance’ about immediate policy rate decisions.

“As I have said in the past, I am sceptical of forward guidance as a tool for central bank communication and policy, at least when understood as providing a definitive view of the short-term interest rate outlook - what is sometimes called forward guidance with a capital F and capital G.

“On my reading of the evidence across jurisdictions, experience of using such forward guidance is, at best, mixed. On occasion, it has started well. But – almost uniformly – it has eventually ended in confusion.

“At a time when policy rates were stuck at their absorbing effective lower bond, a case for forward guidance could be made on the grounds that it allowed for further monetary easing by flattening the forward rate curve when the conventional approach of lowering Bank Rate was no longer available. 

“But – at least for the present – that case no longer holds, now that rates have risen comfortably into positive territory. If some easing were required, bank rates could be raised more slowly than currently anticipated (or even reduced if necessary).”