28/07/2023 No summertime break for the Bank of England who once again risk
criticism both from those who think they haven’t raised interest rates quickly enough and
those who think they’ve done far too much. The Sun
summarised
the
situation in typically pithy style: “Monkeys could run the Bank of England better than its
current bosses”. Former Governor Mervyn King has now weighed in. In an interview on
Bloomberg’s
Merryn Talks Money
podcast he could not have been
clearer
: “The
risk is that having ignored money when inflation was rising, they’re now ignoring money when
inflation is actually about to fall. What we could see, therefore, is a mistake in
both directions over a period of three or four years. If they carry on for the next
six months or so tightening monetary policy, it could well be that they generate both a
recession as well as a sharp fall in inflation”. So will the Bank finally decide enough
is enough after thirteen consecutive increases in interest rates? After all, 5% is a lot
higher than the expected peak a year ago. But that was before the Gilt debacle in the wake
of the Truss/Kwarteng Budget. When interest rates can move so far and so fast, markets start
to believe anything is possible. Unfortunately for Rishi Sunak and Jeremy Hunt, brought in
to restore credibility, the 2 year UK interest rate moved above the Liz Truss levels in
June
. This is largely
due to persistently sticky inflation. The 8.7% registered for headline CPI in May caused UK
yields to
spike higher
, with a
terminal rate of 6.5% priced in. The market has since
fallen back
with the
peak in rates now under 6% after inflation finally came in lower than expectations earlier
this month. This caused the market to anticipate a 25bp hike in August rather than another
50bp whopper. However at 7.9% we are still a very long way from the Bank of England’s 2%
target. Governor Bailey admitted that it was “taking a lot longer than we expected” to get
inflation back down when he
testified
to the
House of Lords Economic Affairs Committee, which features amongst its membership one Lord
Mervyn King. Part of the reason for the delay comes from the way the UK prices energy to
households. The energy price cap is only reset every three months which causes lumps and
bumps in the calculation of inflation. Of more concern to the Bank is inflation in wages
rather than the prices of goods and services. These so-called “second round effects” are
what really spook central bankers because this is what can cause the fabled “wage-price
spiral”. In short, if people have to pay more for stuff, they demand higher wages to enable
them to do so – and from their bigger paychecks they spend even more money, causing the
price of stuff to rise further. And so on. This is exactly the kind of inflation that
central bankers were mandated to prevent. So the latest average weekly earnings data will be
a cause for concern to the BOE as it hit a
record high
of 7.3%
in May: 
This leaves the Bank in a quandary. Monetary policy
always operates with long and variable lags so have they left it too late to stop raising
rates with inflation starting to come down? Or will wages stimulate even higher prices
meaning they need to tighten policy even more now? There will be a new member of the
Monetary Policy Committee at this meeting after Silvana Tenreyro’s term ended. Tenreyro was
renowned as the most dovish member of the committee, arguing that rate rises would take
longer to feed through to the economy because many more homeowners were on fixed rate
mortgages than in the past. She continually voted against raising rates but she has now left
the committee. She has been replaced by Megan Greene, former Global Chief Economist at
Kroll. Greene is certainly alive to the threat that the Bank hasn’t tightened policy enough,
suggesting the last dove has flown the coop. In Greene’s latest column for the FT on 3
rd July she
warned
“it would
be a mistake for central bankers to take comfort in the notion that inflation and rates will
automatically go back to the low levels we saw before the pandemic”. This is going to
be the key message from the Bank, even if they do hike another 25bp at their August meeting
as markets expect. We are indeed nearly at the peak in interest rates. But they’re not about
to come straight back down again any time soon. Lower-for-Longer is dead. Long Live
High-For-Longer. 
Helen Thomas
CEO of BlondeMoney
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