BOE risks hiking too far ahead of the Fed

That was one sharp hawkish volte-face from the Bank of England (BOE). Over the weekend, three Monetary Policy Committee (MPC) members, including Governor Andrew Bailey, made clear that they are ready to raise rates sooner rather than later. The UK government bond market really doesn’t like it.
Gilts, which UK Treasury bonds are called, have been the worst-performing major fixed-income market over the past two months, with the 10-year yield doubling to 1.2%. That is not a vote of confidence in the Bank of England’s communication efforts. All of a sudden everywhere the MPC looks it sees inflation. With that come expectations of future price rises — and the fear of suddenly losing control and the prospect of raising interest rates a lot higher than expected. It is an invidious place for the BOE to find itself. That’s because the world’s central banks — with their vast quantitative easing programs — are, in effect, umbilically-linked. The most important of all to the overall direction of rates is the Fed, which is in absolutely no hurry to rein back stimulus. The US central bank will probably start tapering its bond-buying this year but any interest-rate hike could be delayed given American economic and political circumstances. Furthermore, the European Central Bank and Bank of Japan are still firmly in stimulus mode and several years from contemplating any rate hike. The BOE would win little advantage by acting so far in front of the central bank pack.
Indeed, the UK may commit self-inflicted harm by tightening both monetary and fiscal policy at the same time. That would be especially true if the pandemic recovery peters out because of a China slowdown or an energy price shock that kills demand. Then Britain would have undermined all the slow but steadily herculean heavy-lifting of its stimulus efforts. Stop-start is rarely beneficial especially as the UK’s biggest competitors on either side of the Atlantic are continuing to pour in increasing amounts of fiscal stimulus along with super-benign monetary environments — it risks making global Britain a less obvious place to do business.
What’s behind this hawkish BOE shift? A lot of popular hysteria about inflation and stagflation. The Economist’s Duncan Weldon eloquently argues there are real problems measuring inflation. And the gnashing of teeth about imminent stagflation looks wildly misplaced. The overlooked element to this thesis is unemployment, which for the UK at 4.6% is not far away from pre-pandemic levels and likely to fall further. There is no sign of anything like the stasis of the 1970s. UK growth this year is likely to be above 6% — leading the G7 — and inflation is not rising at the same pace as the US.
The panic is irrational. The BOE has been in stimulus mode for too long without having its faith challenged. But, now, faced with seemingly alarming events, it has lost its religion that inflation is purely transitory. But hiking interest rates is not going to lower the price of natural gas, train more truck drivers or produce more computer chips. It is overseas cost-push inflation that overwhelmingly affects the supply side; so, why respond with a blunt demand-side hammer? George Buckley, chief UK economist for Nomura International, argued in the Times of London that fighting inflation might be the wrong call.

—Bloomberg