A citizen walks in heavy rain near the Bank of England in May 2023.
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LONDON – The Bank of England is “in a bind” as it prepares for a key monetary policy decision amid stubborn inflation and a tight labor market, economists say.
The May consumer price index will be released on Wednesday morning, a day before the bank’s Monetary Policy Committee (MPC) announces its next rate hike.
Data points since the last session point to continued tightening in the labor market and strong underlying inflationary pressures, along with mixed but surprisingly resilient growth momentum.
Economists therefore now assume that the bank will extend its tightening cycle and raise interest rates to a higher level than previously expected.
UK two year government bond yields The US dollar rose to a 15-year high of 5% on Monday before announcing another 25 basis point rate hike on Thursday.
Since November 2021, the central bank has made a series of hikes to raise its policy rate from 0.1% to 4.5%, and market prices are now suggesting it could eventually peak at 5.75%.
Headline CPI inflation was 8.7% yoy in April, compared to 10.1% in March, but core CPI (which excludes volatile energy, food, alcohol and tobacco prices) rose 6.8% compared to 6.2% in the previous month.
The Organization for Economic Co-operation and Development forecast earlier this month that the UK will post annual headline inflation of 6.9% this year, the highest among all advanced economies.
Adding to the general concerns of policymakers was the fact that last week’s jobs data came in much stronger than expected. Contrary to expectations, unemployment fell to 3.8%, while the inactivity rate also fell by 0.4 percentage points.
Regular wage growth (excluding bonuses) was 7.2% yoy in the three months to the end of April, also beating consensus forecasts. Growth in regular private sector salaries, the bank’s key metric, reached 7.6% year-on-year.
On the economic activity front, May PMIs were slightly below consensus but remained in expansionary territory and UK gross domestic product unexpectedly contracted 0.3% mom in March, before resuming part of April with growth of 0. 2% recovered.
Final interest rate forecasts raised
Sven Jari Stehn, chief economist for Europe at Goldman Sachs, said in a research note on Thursday that while there remained some uncertainty about Wednesday’s CPI release, there was a “high hurdle” for the Bank of England to find it necessary to increase their increase increments on a base 50 points basis.
Stehn stressed that “inflation expectations have remained anchored, recent comments have signaled there is no interest in increasing the pace and there will be no press conference or fresh forecasts at the meeting.”
“We expect the MPC to stick to its modal view that underlying inflationary pressures will weaken as headline inflation falls, but acknowledge the more solid recent data and note that risks to the inflation outlook remain clearly on the upside are directed. We also expect the MPC to stand by their assessment.” “The loose forward lead remains unchanged,” Stehn added.
Goldman Sachs expects the MPC to maintain its relatively dovish stance amid robust growth, ongoing wage pressures and high core inflation, with stronger-than-expected data continuing to push the MPC for another 25 basis point hikes, eventually to a final rate of 5.25 % to reach. with upside risks.
BNP Paribas economists are also expecting a 25 basis point hike on Thursday as inflation expectations remain lower than when the bank raised rates in 50 basis point increments last year.
The French lender also raised its final rate forecast to 5.5% from a previous 5% in a statement last week in response to “clear signs of more persistent inflation”.
Although the tightening cycle is expected to last longer than higher to boost inflation, BNP Paribas indicated that the MPC will be “cautious about tightening too much” and will try to gauge how past rate hikes will affect households, especially since Fixed-line Mortgage rate renewals kick off in the second and third quarters.
Mortgage borrowers in the UK are being pushed to the brink as rising borrowing costs affect contract renewals and product withdrawals.
Laith Khalaf, head of investment analysis at AJ Bell, said the MPC was “caught in a quandary” given its choice of pushing more mortgage borrowers to the edge of the cliff or sending inflation into turmoil.
“Current interest rates reflect alarm bells ringing in the market, but some easing of inflationary pressures over the summer would calm things down. The Bank of England will also be aware of the fact that the full force of its tightening to date is still ongoing.” “Working through the economy,” Khalaf said.
“Yet the Bank and Treasury are under pressure to take action if inflation data remains poor, when it seems the Prime Minister’s pledge to halve inflation risks not being met.”