Despite rising price inflation, the Bank of England has voted to keep interest rates on hold at 0.1%.
The Bank’s Monetary Policy Committee (MPC) decided its current monetary policy stance remains appropriate in a unanimous vote. Along with holding interest rates, the MPC also voted unanimously to maintain the stock of sterling non-financial investment-grade corporate bond purchases, funded through quantitative easing, at £20 billion.
There was one dissenting voice in the vote to maintain UK government bond purchases, with eight members of the MPC voting for and one against. This decision means the stock of government bonds will remain at £875 billion. Turning to their projections for the economy, the Bank expects UK GDP to recover strongly this year, returning to its pre-Covid size.
They noted spare capacity in the economy being eliminated as activity picks up, and they also forecast a temporary period of excess demand before demand and supply return to balance. As measured by the Consumer Prices Index (CPI), price inflation is expected to rise temporarily above the Bank’s 2% target, mainly due to rising energy prices. However, as these transitory effects fade away, inflation is expected to return to around 2% in the medium term. Since last month, the Bank noted that developments in global GDP growth have been somewhat more robust than expected, particularly in advanced economies.
The Bank noted that global price pressures had grown further due to strong demand for goods, rising commodity prices, supply-side constraints, and transportation bottlenecks. However, financial markets suggest that rising price inflation is likely to be transitory.The Bank of England revised its forecasts for UK economic growth in the second quarter up by around 1.5% since its report last month. Output this month is expected to be about 2.5% below its pre-Covid level in the final quarter of 2019.
They also noted that the housing market remains strong, and indicators of consumer confidence have improved. Hinesh Patel, Portfolio Manager at Quilter Investors, said:
“As the Bank of England continues to hold fire on any policy decisions, it is approaching somewhat of a sliding doors moment. The ongoing solid economic recovery from the pandemic will be seen as a big positive, but it has brought with it a short-term headache by the way of inflation.
“By headline measures, there is no longer any need for the levels of quantitative easing that markets have become so addicted to. However, with every one in four pounds of public spending coming from borrowing without indirect support from the Bank, debt sustainability will be ever-more problematic in the future.
“Furthermore, while headlines of economic growth may look great, scratch below surface and it’s right for the Bank to continue in its ‘wait and see’ mode before adjusting policy from here. We still need to see the full impact of furlough ending and any structural unemployment that emerges, as well as better understanding transitory vs persistent inflation, before it would be appropriate to act.
“Core inflation is likely to peak this summer, so it may even be 2023 until we see rate hikes given the Bank will want to catch-up to pre-Covid conditions. Quantitative easing, meanwhile, will need to gradually be reduced as the fiscal burden eases.