The Bank of England delay a rate rise.

The October fall in UK CPI inflation from 3.2% to 3.1% should not been seen as a signal that UK inflation has peaked. The direction of price rise travel is upwards with CPI expected to hit 5% in the near term with some commentators suggesting 6%.

Therefore, there is pressure on the Bank of England (BoE) to seek to control inflation because of the threat inflation poses to economies. The usual instrument to quell inflation is interest rate rises. This would come at a time when the UK government, business and mortgage holders could very much do without higher borrowing costs.

In almost every developed country inflation is rising. In the USA it currently stands at 5.3% and this may be the near-term peak for US inflation. This is not the case for Europe or the UK. Here inflation is expected to peak at around 5.5% over the winter months. In Europe inflation is expected to climb to 3.5% but reaching over 4.5% in Germany.

The Bank of England Governor, Andrew Bailey has recently signalled that interest rates will rise sooner than later and that this could start in December with a rate rise from 0.1% to 0.25%. This would be a relatively gently touch on the brake but if inflation persists further rate rises will follow and would hit economic growth.

The Bank of England Chief economist Huw Pill has warned that CPI could exceed 5% in the new year. He added that ‘this is a very uncomfortable place for a central banker with an inflation target of 2%’. The BoE monetary committee meet on 4th November and many are expecting some form of announcement then.

The decision over an interest rate rise will seek to dampen inflationary pressure but will have consequences for borrowers. Markets have priced in a December rise to 0.25% and expect the BoE to continue to rate rise through 2022 ending the year at a base rate of 1%. The BoE has certainly changed its view and policy over rate rises. This change is a response to supply chain pressure as well as petrol and heating cost increases. Some economists feel that the BoE are acting in haste and should wait and see what happens.

The current inflationary pressures are driven by supply problems rather than excessive demand. Prices are up because of inefficiencies in freight, haulage, shipping, manufacturing capacity, inventory reductions, labour shortages and high commodity and energy prices. People have reduced spending and still hold historically high levels of savings. Inflation can be eased as business sorts itself out and greater number participate in the labour market. Economist are expecting inflation to ease as we move into Q2 2022.

Covid has moved the world to a position of shortages, where supply is not matching demand and inflation the outcome. Global supply chains have been managed to optimum efficiency with just in time deliveries not able to cope well in a crisis. The move from fossil fuels to renewable energy has left us with limited back up and on top of this there are in excess of one million job vacancies unfilled in the UK.

Many economists and commentators think that a rate rise will not help the supply problem but could make it worse. Markets are concerned that the BoE will make an unnecessary policy error by prematurely rising rates which they may have to reverse if the economy weakens.

Andrew Goodwin the chief UK economist at Oxford Economics said that he ‘finds it hard to understand why the Bank of England is moving closer to hiking rates when higher inflation is caused by global developments that it does not control and it is hard to find evidence that justify concerns about inflation staying high further out’.

Some members of the BoE own Monetary Committee are concerned about rising rates early as employment is still not full and inflation looks to be transient. The labour market is a key indicator of inflation as raw material prices are cyclical. If wage inflation starts to be embedded and in line with the rising cost of goods, inflation will be more persistent. Perhaps it is this fact that Andrew Bailey is seeking to get ahead of.

Some fund managers do not expect the BoE to follow through on its hint of rate rises this year and will delay a decision well into next year.

All central banks have to consider their massive national debts. The attraction of inflation is that in real terms it reduces the size of the debt but the threat of inflation getting a grip in an economy is that interest rates will have to rise to rein it in. This is why bankers will want to keep interest rates low as long as possible. If UK interest rates hit 1% at the end of 2022 this will have a cost implication to the Treasury as the servicing costs of the UK £2.2tn national debt will rise from the £24.8 b per year it cost us now up to an expected £33.7 b by 2025.

Any rise in inflation can be controlled by companies if the pricing of their goods or services can cover the additional supply costs. Equity markets will not be overly affected by a short-term spike to inflation but would be if inflation was both high and stubborn. The fixed income bond market does not like inflation as it erodes real yields, forces yield hikes and bond price falls. The bond markets are experiencing losses because of this and this could continue. For this reason, we have moved virtually all our bond holding to short dated or inflation linked in order to protect values.

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