The Bank of England’s Monetary Policy Committee (MPC) voted 7-2 to hold interest rates amid sticky inflation, with a decision to slow down its quantitative tightening (QT) process also made in light of febrile markets raising borrowing costs.
MPC members made a dual decision at its September meeting on interest rates and the sale of gilts it holds on its balance sheet, which economists believe has worsened borrowing costs faced by Treasury given it incurs losses from sales and has to face higher gilt yields.
The Bank said it was “focused on squeezing out any existing or emerging persistent inflationary pressures” in order to hit its two per cent target rate, which led to a decision to keep interest rates at four percent.
Inflation hit 3.8 per cent in the year to August, with food prices rising higher for the fifth consecutive months.
Andrew Bailey said: “Although we expect inflation to return to our two per cent target, we’re not out of the woods yet so any future cuts will need to be made gradually and carefully.”
Bank officials pointed to Reeves’ tax hikes at last year’s Autumn Budget as forcing employers to adjust costs.
They also emphasised that price growth was easing in services though minutes from the meeting provided warnings that inflation expectations were “elevated relative to historical averages”.
MPC members Megan Greene and deputy governor Clare Lombardelli have pointed to the threat of high inflation expectations.
The two members to vote for a 25 basis point cut at the September meeting were Swati Dhingra and Alan Taylor, who have both taken a more dovish stance on interest rates.
Taylor and Dhingra believed the “inflation hump” would ease as they pointed to lower wage growth and low domestic demand, exacerbated by cracks in the UK jobs market.
The Office for National Statistics (ONS) said earlier this week that 142,000 jobs had vanished over the last 12 months.
Quantitative tightening decision
Markets widely expected interest rates to be held but traders were looking ahead to the Bank’s decision on updates to its quantitative tightening (QT) process, which has seen the Bank reduce the size of its balance sheet to offer it more “flexibility” in case of future crises.
The Bank made the decision to reduce the size of its annual QT target from £100bn in the last year to £70bn in the next 12 months.
Sales of active gilt sales would total £21bn, compared to £13bn the previous year, with the rest of the reduction to come through expiry of matured bonds and non-reinvestment.
The Bank said it would sell fewer long-term gilts than short and medium-term gilts in light of pressures in 30-year gilt markets, which have added to pressures on Reeves ahead of the Autumn Budget. This is a change in stance from previous years when gilts were sold at similar rates.
The Bank said it would sell half as many long-term gilts as medium and short term bonds. Most MPC members agreed with the decision,
Catherine Mann voted for sales to slow down more to £62bn while chief economist Huw Pill supported the pace of gilt sales to be maintained at £100bn.
“The new target means the MPC can continue to reduce the size of the Bank’s balance sheet in line with its monetary policy objectives while continuing to minimise the impact on gilt market conditions,” Bailey said.
Its first sale of long-term gilts is set to come around two weeks before the Budget.
Some analysts have blamed the Bank for dumping gilts and lowering the price of gilts, which has deepened the crisis faced by Reeves in the bond markets as yields have soared.
Higher borrowing costs are expected to be forecast by the Office for Budget Responsibility (OBR) later this year, forcing Reeves to look for extra revenue through tax hikes.