Stagnation looming for UK economy as BoE signals it may soften policy going forward – POLITICO

The pound had its worst day in two years on Thursday, after the Bank of England admitted what every central bank is reluctant to admit: some problems are just too big to solve.

The bench warned grimly that it “cannot prevent” a decline in profit margins and household incomes due to the enormous increase in energy prices. But she acknowledged that to stop a destructive wage-price spiral from forming, she needed to add to the pain with higher interest rates.

The bank’s report illustrated what private sector analysts and Governor Andrew Bailey have acknowledged for some time: the UK is combining the worst aspects of the outlook for the US and euro-zone economies with consumer spending power being hampered by runaway inflation and a struggling labor market is hampered by a massive lack of human capital.

The bank raised interest rates by 0.25 percent for the fourth straight month, to a 13-year high of 1 percent. But the expected slowdown in the economy – already evident in falling consumer confidence and falling retail sales figures – means the end of monetary tightening could already be in sight, analysts said.

“The cautious tone of the meeting and a dovish set of new guidance suggest the bank’s tightening cycle will be much less aggressive,” ING analyst James Smith said in a note to clients. “We expect another rate hike in June and probably another in August before the committee hits the pause button.”

In his regular update, the bank lowered its growth forecasts for the next few years and said the economy will contract over the summer before recovering weakly thereafter. Unemployment is expected to rise from the current 3.8 percent to 5.5 percent within three years.

At the same time, the BoE now expects inflation to peak above 10% in the fourth quarter of this year as the rise in global energy prices forces regulator Ofgem to lift the ceiling on household bills again. Deputy Governor Ben Broadbent told journalists at the bank’s news conference that this “external” shock is responsible for 80 percent of the inflation excess.

High energy prices, the bank said, “are bound to continue to weigh on the real incomes of most UK households and the profit margins of many UK businesses”.

The worst prospects of both worlds were reflected in deep divisions within the nine-member Monetary Policy Council. Some were now urging tougher action on inflation, while others felt it was inappropriate to warn that further rate hikes may still be needed. Three of the nine voted in parallel with the US Federal Reserve’s decision on Wednesday to raise interest rates by half a point.

Such splits could pose acute difficulties for the bank in communicating its policies over the coming months. But it seemed somewhat prepared for criticism for fueling the burgeoning cost-of-living crisis by raising the cost of borrowing.

“We’re concerned about second-round effects,” Bailey said, warning that “those with the least bargaining power will suffer the most” when wages and prices start chasing each other up.

Average earnings growth, including bonuses, accelerated to 5.4 percent in March, above what the bank says is consistent with its 2 percent inflation target.

market slump

Financial markets took the news poorly. Sterling, which has been under pressure since the International Monetary Fund downgraded its forecast for the UK economy last month, fell almost 3 cents to below $1.2350 against a resurgent dollar as currency traders priced in a widening interest rate differential with the US

Contrary to the BoE, Fed Chair Jerome Powell had signaled on Wednesday that a series of half-point hikes in US interest rates were likely, greatly increasing the relative attractiveness of holding dollars. The pound also lost almost 1.5 cents against the euro.

In bond markets, UK government bond yields fell sharply before being pulled higher by US bonds later in the session.

The more pessimistic growth outlook means the bank almost certainly won’t start selling the pile of sovereign debt it acquired during the pandemic for at least another four months. The staff will present draft proposals for active bond sales to the MPC meeting in August. Actual sales are not expected to begin before September.

In a separate market note, the bank announced that it will simultaneously begin selling its £20 billion corporate bond portfolio, aiming to complete the process by early 2024 at the latest.

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