While the ECB and Federal Reserve are loosening monetary policy, the UK is holding out. Why?
• Amid a general vogue for looser monetary policy, the stance of the Bank of England looks anomalous.
• UK inflation came in at just 1.7% in August, down from 2.1% in July and below economists’ consensus.
• The inflationary threats in the UK lurk beneath the surface.
Central bankers have been busy this week. The ECB has cut the deposit rate and resumed its quantitative easing programme. At the same time, the markets have it as a racing certainty that the Federal Reserve will lower rates at their next meeting. The only question appears to be the magnitude of the cut.
Amid this general vogue for easing monetary policy, the stance of the Bank of England looks anomalous. It continues to hold out on further monetary easing measures. Interest rates remain at 0.75% and, at its August meeting, the monetary policy committee reaffirmed its pledge to raise rates gradually, assuming a smooth Brexit and some recovery in global growth.
This stance looks even more unusual when inflation figures are taken into account. The most recent ONS figures showed UK inflation dropping like a stone in August. UK inflation came in at just 1.7%, down from 2.1% in July and below economists’ consensus.
What explains the Bank of England’s stance? Without wishing to second-guess the UK’s leading economists, it may be that both Brexit and the oil price are playing a role in their thinking. With a deal elusive, a ‘no deal’ Brexit continues to seem like the most likely scenario. This would almost certainly prove inflationary as tariffs are imposed under WTO rules: cars would be taxed at 10%, for example, when they cross the UK-EU border, while tariffs on dairy products may rise as high as 35%. It may be that the Bank of England is keeping some powder dry for this scenario.
This week also saw volatility in the oil price following attacks on Saudi Arabian oil installations. The oil price spiked 20% at one point. While it moved back to more normalised levels later in the week, it was a reminder that lower inflation has been partly supported by a falling oil price. That trade remains vulnerable to tensions in the Middle East.
There are no immediate inflationary pressures and, in the long term, the trend appears to be in the opposite direction. However, the Bank of England will be grimly aware of the hit to confidence inherent in being forced to raise rates rapidly in response to an inflationary threat. As such, it is treading a fine line. In this context, its stance may not be as abnormal as it first appears.
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