The Bank of England’s MPC is expected to cut UK interest rates at its first meeting of the year this Thursday, but, sharing her latest analysis, Hetal Mehta, Head of Economic Research, St. James’s Place, reminds us that economic uncertainty, inflation risks, and labour market strains might still complicate policy decisions.
Mehta says “At the December meeting, the BoE made a dovish pivot that signalled a willingness to support growth despite the inflation risks. It would come as a major surprise to economists and markets alike if the BoE did not vote to cut rates on Thursday.
“Unlike the Fed, the BoE will be less confident in the ‘solid’ nature of the labour market. Wage growth may be sticky, and surveys show price expectations have firmed in recent months but a variety of indicators are showing employment strains, complicating the policy stance. As such, it shouldn’t come as a surprise that the MPC will be most likely be split – even three ways.
“In the coming months and in the medium term, the BoE will have to monitor closely how the price signals manifest themselves in the data. High inflation risks the second-round effects being stronger; the pass-through from the National Insurance tax increases are likely to also keep the MPC cautious and only on a gradual cutting path.
“The news of tariffs levied by the US against Canada, Mexico and China will inevitably raise questions on how central banks – especially the ECB but also the BoE – should respond should they also be subject to such protectionist measures. It is too late for the BoE to adjust its forecasts and assumptions for global growth, but any further weakness in the euro area economy will likely spillover to the UK. For some MPC members, the case for a pre-emptive cut may be enhanced.
“One other point of interest in the Monetary Policy Report will be the Bank’s refreshed assessment of the supply side of the economy. Typically, the BoE and OBR have had very different views on potential growth, with the Bank being far more pessimistic. Latest upward revisions to long term net immigration should be a boost to the labour supply and therefore better for growth, although productivity and impacts on inflation are uncertain.”