The fall in inflation from 10.1% in July to 9.9% last month will not worry Bank of England policymakers at their interest rate-setting meeting next week. Its Monetary Policy Committee (MPC) is on a mission to raise the cost of borrowing to bring inflation down to 2%. The price growth of almost 10% is still too high. One-month figures are not a trend.
The nine MPC members will also reflect on several other domestic and foreign developments that can be seen as reasons for a rate hike.
Topping the list is the government’s $150 billion energy subsidy program.
Wealthier households are more likely to spend money on scarce imported items, forcing retailers to keep raising prices. Higher interest rates will affect monthly mortgage bills and persuade them to rein in spending. At least that’s the theory.
Wages are another issue worrying the bank’s rate setters. In July, wage growth rose to 5.2% from 4.7% in June. While these numbers are well below inflation and reveal the worst fall in living standards in two generations, they still worry the MPC, who fear higher wages will translate into higher prices in years to come once other business costs have calmed down.
James Smith, economist at ING, said the £2,500 price cap on household energy would prevent inflation from soaring above 11%. “But the Bank of England is keeping a closer eye on wage growth as hawks fear labor shortages could mean core inflation stays above target more permanently,” he added.
Finally, there is the impact of inflationary trends in the rest of Europe and the US. The European Central Bank hiked interest rates by a record margin last week to fight inflation, while the US Federal Reserve is poised to lower lending rates to 8.3% despite a fall in inflation from 9.1% in June to increase further in August .
The dollar will rise and the pound will fall if global investors can get a better return on New York deposit accounts. If sterling falls, foreign import prices will continue to rise, putting even more pressure on UK inflation.
Arguments against fighting inflation with higher interest rates are likely to fall on deaf ears. The pressure on the bank to follow its peers — if only to prevent the currency from falling further — will be too strong, most analysts say.
In the City, debate is centered on whether Threadneedle Street will hike interest rates by 0.5% or follow the Fed and ECB with a whopping 0.75% hike.
George Lagarias, chief economist for accountant Mazars, is among those arguing that the looming recession and panicked household response will push inflation lower. He said that instead of increasing spending, most households are being cautious, which is already showing in higher savings rates.
“If consumers remain sufficiently conservative with their discretionary spending and the economy slows as predicted, we could actually be talking about deflation rather than inflation by the end of 2023,” Lagarias said.
If that happens, the Bank of England will be accused of taking us on a roller coaster ride as it rode calmly through the storm.