Partner Content: CCLA Investment Management’s Robert Evans analyses the MPC’s increase in the Official Bank Rate to 0.75% and its warning that inflation could reach 8% in the second quarter of 2022.
The Bank of England’s Monetary Policy Committee (MPC) has sent a signal that it remains committed to tackling inflationary pressures by voting to restore its Official Bank Rate back to its pre-Covid level of 0.75%. The 0.25% increase, announced on 17 March, means the Bank has now raised interest rates at three meetings in a row – for the first time since 2004.
There had been speculation before the meeting that some MPC members might opt for a 0.50% increase, but only one – Sir Jon Cunliffe – dissented from the majority, surprisingly voting to keep Bank Rate on hold. A significant swing from last month, when four members voted for a 0.50% increase.
The MPC adjusted the guidance for its policy-setting direction over the next few months. Instead of indicating a tightening of monetary policy was “likely”, it said it “may be appropriate”. It added “there are risks on both sides of that judgement depending on how medium-term prospects for inflation evolve”. The MPC appeared more concerned than previously on the potential for a marked slowdown in activity over the coming months, as the negative impacts of higher commodity prices weigh on real household incomes and activity.
An increase was widely expected with markets in fact pricing in a 0.31% rise, implying that it saw about a 20% chance of a 0.50% increase. Following the announcement, and the more hesitant comments from the MPC, market expectations for the path of bank rate shifted lower. The market now sees rates reaching approximately 2.05% in the middle of next year, down from 2.25% before the announcement. Investors also reduced the chances of rates rising above 1% by June which was projected by the market prior to the meeting.
The pound fell following the decision and statement, with Sterling falling just under 1% against the dollar to below $1.31, although half of the drop had recovered at the time of writing.
Room151’s Monthly Online Treasury Briefing
March 25 2022
Online
Public sector delegates – register here
Rationale behind the increase
Clearly the Bank remains determined to be seen to be fighting the soaring level of inflation. The Bank now expects inflation to rise further in the coming months to around 8% in the second quarter of 2022 – about one percentage point higher than forecast in February – and potentially to climb even higher in October, when the energy price cap looks set to be lifted again. We could see inflation temporarily hit double digits, with disruption to global supply chains also threatening to fuel core goods inflation.
The minutes of the MPC meeting make 21 references to energy inflation and eight references to commodity price growth. The Bank has been at pains to highlight that it is limited when it comes to confronting this kind of inflation – it states that this is “something monetary policy is unable to prevent”.
Given that the Bank is clear that rate rises will have limited effects on this input inflation, we can take away that the strength of the labour market was the main justification for the rate rise, as the Bank looks to head off second-round inflation effects such as rapid pay growth. The minutes of the meeting show that the MPC wanted to tighten monetary policy to prevent inflationary expectations becoming “embedded”, citing rising prices and nominal wage growth. Three key references on this topic were made within the Bank’s press release:
UK activity had been somewhat stronger than had been expected at the time of the February Report and there had been indications that the current tightening in the labour market might not reverse direction as quickly as had been expected.
Monetary policy should be tightened at this meeting in order to reduce the risk that recent trends in nominal pay growth, domestic pricing, and inflation expectations strengthened and became embedded, and thereby to help to ensure inflation was at target sustainably in the medium term.
Given the current tightness of the labour market, continuing signs of robust domestic cost and price pressures, and the risk that those pressures would persist, most members of the Committee judged that a 0.25 percentage point increase in Bank Rate was warranted at this meeting.
Impact of high inflation
The MPC now appears more concerned about the adverse impact of high inflation (and tax rises) on domestic demand, rather than the risks that inflation expectations will become entrenched, thereby triggering above-target wage growth over the medium term. The Bank fears that growth and employment, will be weaker than expected a month ago, with inflation further reducing household incomes. In its statement the Bank said:
Consumer confidence has, however, fallen in response to the squeeze on real household disposable incomes. That impact on real aggregate income is now likely to be materially larger than implied by the projections in the February Report, consistent with a weaker outlook for growth and employment, all else equal.
These concerns have been made worse by the Russian invasion of Ukraine which, according to the Bank, will lead to:
Further large increases in energy and other commodity prices including food prices. It is also likely to exacerbate global supply chain disruptions, and has increased the uncertainty around the economic outlook significantly. Global inflationary pressures will strengthen considerably further over coming months, while growth in economies that are net energy importers, including the United Kingdom, is likely to slow.
Future path for Bank Rate
The MPC appears very keen to front load hikes to guard against the risk of inflation expectations spiralling. Another 0.25% rate increase in May as still more likely than not as the Bank looks to manage the momentum in the labour market, but the potential for high energy costs to reduce spending power and weaken the economy means that a pause can be expected in the second half of the year, while the bank assesses future economic performance.
It is the risk of this demand-side inflation within the labour market that could determine further moves in Bank Rate in the second half of the year.
Despite the more “dovish” comments from the Bank, the market-implied interest rate path now shows rates rising to 2% within the next 12 months, compared with 1.5% in February, which presently still looks aggressive.
Impact on deposit funds
Since the start of the year, CCLA has been positioning the investments within its three cash funds to allow for their net yields to quickly react to this new rate environment. Using the Public Sector Deposit Fund (PSDF) as an example, within the next seven days 59% of the holdings will have been rolled over at the new higher rates, 71% within a month and 88% in less than three months. Therefore, we should see a relatively quick readjustment in their net yields.
Given the volatility in the yields for longer-dated sterling maturities, we have been reluctant to extend the average duration of fund in an effort to avoid a decline in investment values.
The CBF Church of England Deposit Fund declared rate will increase today (Tuesday 21 March) to 0.60%. By close of business on Friday 18 March, we expect the PSDF net yield to be around the 0.55% level, while our COIF Charities Deposit Fund should be around the 0.48% mark.
Robert Evans is senior portfolio manager at CCLA Investment Management.
Disclaimer
This document is issued for information purposes only. It does not constitute the provision of financial, investment or other professional advice. Past performance is not a reliable indicator of future results. The value of investments and the income derived from them may fall as well as rise. Investors may not get back the amount originally invested and may lose money. Any forward-looking statements are based upon CCLA’s current opinions, expectations and projections. Such opinions, expectations or projections may be subject to change at any time. CCLA undertakes no obligations to update or revise these. Actual results could differ materially from those anticipated.
—————
FREE weekly newsletters
Subscribe to Room151 Newsletters
Room151 LinkedIn Community
Join here
Monthly Online Treasury Briefing
Sign up here with a .gov.uk email address
Room151 Webinars
Visit the Room151 channel
