After the MPC’s historic second vote on interest rates, is the Bank of England torn between fears of recession and inflation, asks Helen Thomas
Seventeen years ago this month, the Bank of England produced its quarterly Inflation Report
as usual. In the 56 pages, the Bank’s forecasters laid out carefully crafted charts and
analysis of how growth would ultimately pick up and inflation risks were, in central banker
parlance, “judged to be on the upside”. The MPC voted unanimously to maintain interest
rates at 5.75 per cent. A month later, Lehman Brothers went bust, growth plummeted and interest
rates were eventually slashed to almost zero. And yet the word “recession” never made its
way into that summertime inflation report, even as a potential risk.
Fast forward to the current hot summer and the latest (re-named) Monetary Policy Report
from the Bank of England still doesn’t mention this word. But the Minutes of the August
meeting do, courtesy of the newest member of the Monetary Policy Committee, Alan Taylor.
Since joining the MPC a year ago, he has voted for bigger interest rate cuts than the rest of
the committee half of the time, establishing himself as the uber dove. He outdid himself in
the latest meeting, voting for a more aggressive 50bp cut. This led to an unprecedented
second round of voting as there had been a tie, with an even split between the other eight
members of the committee: four wanted only a 25bp cut and four others preferred rates to be left
unchanged. Taylor switched to a 25bp cut in the second vote and hey presto, he got interest
rates lower, even if not by as much as he had wanted.
A second vote has never taken place in the history of the MPC since it became independent
in 1997. What motivated such a dramatic turn of events? Taylor made it clear in the minutes
of the meeting: “This picture was one of downside risks in coming years, namely: inflation
below forecast, and activity weak or an increased risk of recession. For insurance against
this balance of risks, a less restrictive policy was warranted”. And there it is, one tiny word
with big consequences: recession.
Policymakers don’t like to mention it, for fear of self-fulfilling prophecies. If businesses and households think central bankers and governments are worried about a recession then they’ll take precautions, recruiting less and saving more. Such activity can then induce a slowdown, fears of recession increase further, consumers spend less, and on it goes. Better not to mention it but work behind the scenes to ensure it doesn’t come about.
Taylor could be entirely wrong. It’s his job as an external member of the MPC to provide a
fresh viewpoint from beyond the walls of Threadneedle Street. And he clearly had a job on
his hands convincing all of his colleagues to join his assessment. This has left financial
markets perplexed, wondering if the Bank will now sit on its hands and see how things pan out, given even its own members can’t agree on the way forward for the UK economy.
On the other side there sits the chief economist Huw Pill, who voted for no change in rates.
He is more worried that inflation will remain above target. After all, the Monetary Policy
Report contained higher inflation forecasts than the prior quarter and noted ‘the MPC judges
that the upside risks around medium-term inflationary pressures have moved slightly higher
since May’. All else being equal, the risk of higher inflation should mean interest rates can’t
move much lower.
In particular, Huw Pill is worried that the return of high inflation will itself beget higher inflation
because of “changes in behaviour…of a more lasting nature”. In short, we might now be in a
world where when we see prices go up, we start to expect they’ll go up in the future. Central
banks need to keep a lid on these increasing inflation expectations or they can get out of
control. Just as fear of recession can create a slowdown, a fear of inflation can create higher
prices. Workers demand higher pay, one business puts up their prices to protect margins, other businesses do the same, workers find their money doesn’t go as far and then demand
higher pay, and so on.
The pandemic changed our parameters for what we expect of the future. We worry that it
won’t just be business as usual, but rather a shock could come along and jack up the price
of the weekly shop. The BOE is particularly worried about this, warning of “households’
attentiveness to food prices”.
Once bitten, twice inflated. Bruised and bashed British consumers are on alert. The Bank of
England is now split over whether they should be more worried about a recession or the
return of high inflation. If history were to rhyme with the 1970s, they might get both. Best to
continue to enjoy the summer heatwave and let the policymakers thrash it out between
themselves.
Helen Thomas is CEO and founder of Blonde Money