Bank of England takes heat for hawkish stance as UK inflation cools

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After a flat-footed response to the inflationary upsurge in 2021, the Bank of England is heading into the new year facing a barrage of complaints that it is proving too slow to recognise the marked retreat in UK price growth. 

Official data on Wednesday revealed a steep dive in the rate of consumer price growth to 3.9 per cent in November, a much lower reading than had been forecast by economists and down from 6.7 per cent as recently as September.

The figures sparked a sharp reaction in financial markets, as investors boosted their bets that the BoE will start easing policy far sooner than its official communications suggest. 

The numbers, which also showed lower readings for core inflation and services price growth, came just days after the Monetary Policy Committee insisted it remained ready to lift rates higher than 5.25 per cent if necessary, as the UK lags its peers in tamping down price growth.

Three of the central bank’s rate setters also persisted with demands for an increase in the key interest rate to 5.5 per cent.

Analysts including Benjamin Nabarro of Citi warned that the BoE was waiting “too long to pivot” on monetary policy as it awaited more conclusive evidence that it had quashed the UK’s inflation problem.

Line chart of Year on year % change  showing A range of UK inflation measures are in sharp retreat

“The bank has been insisting we will see a frustratingly gradual process of disinflation, but this is not being borne out by the data, which have been showing rapidly receding price growth for some months now,” Nabarro said.

“Their concern about their past mistakes when inflation shot up are not an excuse to sit tight for too long now and drive UK unemployment higher than it needs to go,” he added.

The market has made up its own mind, pricing in a quarter-point cut by May, with rates tipped to fall by 1.38 percentage points over the course of 2024.

Having battled to regain its inflation-fighting credibility by lifting rates 14 times in a row, the BoE remains wary of relaxing monetary policy early in 2024 only to find itself dealing with a fresh price spike.

Diversions to shipping in the Red Sea because of attacks by Iranian-backed Houthi rebels in Yemen have underscored the continued risks of disruptions that can drive some prices higher. 

A number of key indicators followed by the BoE — including wage growth and services price inflation — also remain too high for comfort, economists said.

Services price inflation retreated to 6.3 per cent in November from 6.6 per cent previously. Though the figure was below expectations, economist George Moran at Nomura argued the momentum in that indicator remained “substantially above” the levels the BoE would want to see as it sought to get inflation back to the 2 per cent target.

Line chart of Annual % price growth  showing UK inflation remains higher than in several peers

“Even if near-term data prove weaker than expected, the BoE could very well be reluctant to make a quick change of course, and rather prefer to potentially be behind the curve in order to be certain of the downward trajectory,” he wrote on Wednesday.

Huw Pill, the bank’s chief economist, has argued that persistently tight monetary policy will be needed given stubborn growth in both wages and services price inflation — a strategy he dubs “Table Mountain” after the South African landmark. 

The BoE’s peers, most notably the European Central Bank, have also been actively pushing back against investor speculation that rates will fall soon.

Ben Broadbent, a BoE deputy governor, on Monday warned that officials struggling to make sense of a “slightly muddy” picture on labour market data were unwilling to jump to the conclusion that the trends were now firmly downward.

Wage growth has fallen from a summer peak of 8.5 per cent on official measures, but given contradictory data the BoE wants to see a “more protracted and clearer decline” before relaxing policy.

Sarah Breeden, the newest MPC member, said on Tuesday that on most measures wage growth was “several percentage points” above the level consistent with 2 per cent inflation, given sluggish UK productivity growth.

However if current downward trends in inflation continue, alongside an economy that is at best flatlining, the BoE’s hawkish position will come under increasing pressure, especially as 2024 is set to be an election year, analysts argue. The next key moment will come in February, when the BoE sets out its next set of forecasts. 

Erik Britton, chief executive of economics consultancy Fathom, said that given sticky readings on wages and services prices the BoE would be taking a risk if it cut rates soon in 2024.

But he argued the BoE should err on the side of easing policy given signs of a weakening economy, adding that the central bank could reverse course if necessary.

“I would rather take that risk instead of incurring a big recession in the UK,” he said. “They can always row back.”

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