After a year without communicating a clear view about the direction of the UK economy, the Bank of England just got off the fence. Thursday’s quarter-point rate rise to 5.25 per cent, made at least a month before the market expected, is certainly more justified than the BoE’s surprise rise in August. Indeed, with consumer price inflation now far above target at 2.7 per cent, retail price inflation – which includes housing costs – at a nine-year high of 3.9 per cent and the housing market heading back to the stratosphere, the Bank arguably needed to re-establish its credibility.
That took rather a knock in 2006. The high turnover of monetary policy committee members was one factor. But the BoE’s forecasting, which was reasonable for 2005, was quite poor for 2006. Current CPI and interest rates are 90 and 75 basis points respectively above its projections of November 2005. There were some curve-balls such as the impact of tuition fees on CPI and statistical revisions that suggested a smaller output gap. But the reality is that, in the past year, the MPC has presided over a major shift in rates while simultaneously indicating that only tweaking was needed. The BoE has been second to none in enunciating the risks, in either direction, to the inflation outlook. But it has been pretty hard to identify any consistent opinion on where the economy was going.
That void has now been filled by a hawkish bias. New forecasts in February’s Inflation Report are likely to err on the side of caution. It will take months of data to convince the MPC that wages are not rising. Hawks can also point out that UK policy is not actually that tight: real rates, defined as base rates less CPI, are 45bp below the US and 105bp below the UK average since the BoE was handed control of policy in 1997.
In spite of the European Central Bank’s decision on Thursday to hold, a rise in expectations for eurozone real rates – still too low given Germany’s recovery – remains investors’ best bet. The BoE’s reputation for fickleness is flowering. But the one thing it does now seem clear about is that it wants to be seen to be acting against the first major overshoot of its inflation target since independence.
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