JP’s Journal: The MPC finally moves

Finally, Monetary Policy Committee (MPC) members could no longer resist the pressure. By opting to maintain the emergency cut through 2021 when conditions were more favourable to start tightening policy, they found themselves outmanoeuvred by events.

In the end, the move higher came at the same time as a growth warning with the Bank of England reducing its GDP forecast. Despite Omicron and the likely squeeze on personable disposable income in 2022, the MPC decided it could not ignore the current price pressures and the prospect of higher inflation next year.

In truth the move makes no real difference – it is symbolic – and that is why I think the MPC should have moved earlier. Yes, there may be a marginal impact on mortgage rates but the healthy competition in this market does not make that certain. It seems to me that the behavioural tendency in the MPC is to ‘wait and see’. This can be an appropriate response but the continuation of extremely low interest rates over a long period of time has risked sending the wrong messages. Effective decision making depends on making the right call at the right time. By waiting, I believe MPC members have complicated their task and given the impression they are behind the curve. In their defence, the curve is saying that rates don’t need to go up much anyway. Indeed, there was little impact on the level or shape of the gilt curve, with 10-year yield ending the week at 0.75%.

Let’s look at what the MPC said in a bit more detail. They have revised their CPI inflation forecasts up to 6% in April 2022 and point to significant upside pressures in core goods and, to a lesser extent, services. In reality higher domestic rates won’t impact global inflation factors such as energy. What was striking in the minutes was their concern about inflation becoming embedded in business and consumer expectations, and thus feeding through into wages. And here we encounter a political problem. Part of the Government’s agenda is to ‘level-up’, which means paying more to people who have lost out from globalisation. It will take all of the Government’s skills to navigate through this. Faced with Covid, labour shortages, higher taxes, more money needed for essential services, rising prices, and falling popularity, the New Year will be a tough time for both the consumer and the Cabinet.

In the US and Europe last week it was not plain sailing either. The US President’s $2 trillion fiscal package fell foul of a lone Democrat senator and now faces a possible rewrite while in the euro area, lockdowns are being re-introduced and Covid passports required for events. Against this depressing background, government bonds did well. Yields on 10-year US treasuries moved lower, hitting 1.4% while the German equivalent ended at -0.4%. Implied inflation softened across the board as the growth implications of Omicron were considered. In the UK 30-year implied inflation fell to 3.3%, some way back from the 3.7% seen in October. In the US the retracement has been similar, although from a materially lower level.

Credit markets took their cue from the ‘risk-off’; move. High yield spreads moved wider, although these are still below the level of four weeks ago. Investment grade sentiment also weakened but the impact on indices was not marked. Indeed, we did not see much sell-off in the usual ‘risk-off’ candidates such as banks and insurance. Liquidity has continued to shrink in the sterling market as we approach Christmas and it has been difficult to get offers. I think we will have a lot more choice in January as markets are re-energised.

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