A close decision was expected at today’s meeting of the Bank of England’s Monetary Policy Committee (MPC), which delivered the first interest rate cut since the start of the Covid pandemic. That was exactly what we got. Five members voted for an interest rate cut – and four voted to hold rates at 5.25%.
The make-up of each group was also significant. The five cutters were led by the Governor and contained his three deputies plus Swati Dhingra, an external member who has been voting for a cut for some time. The four dissenters were the other three independent external members, plus the Bank’s Chief Economist, Huw Pill. In other words, it was the Bank establishment leading the rate-cutting group, while the independent external members made up the bulk of those who wanted to hold interest rates to counter inflationary pressures.
The arguments informing both groups were those which have been aired in the economic debate in the run-up to the meeting. The rate-cutters wanted to respond to the recent fall in inflation to target, and thought that worries about ‘sticky inflation’ in the services sector and from high wage growth would soon subside. The group arguing for an interest rate hold wanted to exert more direct downward pressure on inflation by keeping the Bank Rate at 5.25% for longer. The cutters were also worried about the fragility of growth, while the hold camp was more confident that the pick-up in UK growth this year would be sustained.
If I had been on the MPC today, I would have voted with the holders, not the cutters. One of my reasons for doing so would have been the need to repair the Bank’s anti-inflationary credibility after the biggest inflation surge while the MPC has been in control of UK monetary policy. Adding to this concern was the prospect that headline inflation was likely to rise in the next 6-12 months, according to most independent forecasts. Today the Bank confirmed that this was a feature of its central forecast too.
So the arguments which held sway today contain a fair degree of risk. The first major risk is that the expected rise in headline inflation will combine with other upward pressures on pay and prices – such as high public sector pay settlements – to set off another surge in inflation. The second major risk is that the ‘sticky inflation’ problem – of high wage growth and services inflation – will prove more persistent.
The group on the MPC arguing to hold rates were supporting a more ‘safety first’ strategy when it comes to inflation. Interest rates could be held at 5.25% until there was stronger evidence that inflation was clearly under control and on a sustainable path to the 2% target.
It might seem curious that the Governor and his deputies are keen on taking risks, while other members of the MPC are urging caution. Surely the establishment at the Bank of England should be the cautious group? I put this behaviour down to the tendency of senior Bank officials to follow media and political pressure – which has certainly been in the direction of cutting interest rates throughout this year.
Indeed, we seem to be a nation addicted to low interest rates, which we saw with the long period of near-zero interest rates in the 2010s. That did a lot of damage to the UK economy in terms of low economic growth. Similarly, the senior officials at the Bank of England were also slow to pick up on the 2021-24 inflation surge, and very reluctant to raise interest rates at all in 2021.
So what happens next? The close vote at the MPC would suggest that any further reductions in interest rates will be slow and cautious. There is no urgency to reduce rates to stave off recession or head off deflation. Instead, the UK economy would benefit from a prolonged period of Bank Rate around 5%, to help subdue sticky inflation and head off future inflation risks.
So the rate-cutters may have won the day at the August MPC, But this is the first round of a series of meetings where the ‘hawks’ and ‘doves’ will test each other’s arguments. My hope is that the ‘holders’ will prevail over the ‘cutters’ until we can be more sure that inflation has been put fairly and squarely back in its box.
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