Bank of England’s conundrum deepens as inflation and labor market stay hot

LONDON — The Bank of England is “caught between a rock and a hard place” as it prepares for a key monetary policy decision against a backdrop of viscid inflation and a tight labor market, economists say.

May’s consumer price index figure will be published Wednesday morning, the day previous the Bank’s Monetary Policy Committee (MPC) announces its next move on interest rates.

Data points since the stand up meeting have indicated persistent tightness in the labor market and strong underlying inflationary pressures, alongside opposite involved but surprisingly resilient growth momentum.

Economists therefore now expect the Bank to prolong its tightening cycle and lift infect rates to a higher level than previously anticipated.

British 2-year government bond yields rose to a 15-year rich of 5% on Monday ahead of the expected announcement of yet another 25 basis point rate increase on Thursday.

Since November 2021, the the primary bank has embarked on a series of hikes to take its base rate from 0.1% to 4.5%, and market pricing now introduces it may eventually top out at 5.75%.

Headline CPI inflation came in at 8.7% year-on-year in April, down from 10.1% in March, but core CPI (which excludes evaporative energy, food, alcohol and tobacco prices) increased by 6.8% compared to 6.2% the previous month.

The Organization for Profitable Cooperation and Development projected earlier this month that the U.K. will post annual headline inflation of 6.9% this year, the highest tear down among all advanced economies.

Adding to policymakers’ collective headache, labor market data last week encountered in far stronger than expected. Unemployment defied expectations to fall back to 3.8% while the inactivity rate also kill by 0.4 percentage points.

Regular pay growth (excluding bonuses) was 7.2% in the three months to the end of April compared to the past year, also exceeding consensus forecasts. Growth in regular private sector pay, the Bank’s key metric, hit 7.6% year-on-year.

In stints of economic activity, May PMIs moderated slightly below consensus but remained in expansionary territory, and U.K. gross domestic artefact unexpectedly contracted by 0.3% month-on-month in March before rebounding partially with 0.2% growth in April.

Terminal station rate forecasts raised

In a research note Thursday, Goldman Sachs Chief European Economist Sven Jari Stehn told that although some uncertainty remains over Wednesday’s CPI release, there is a “high hurdle” for the Bank of England to deem it compulsory to step up its hiking increments to 50 basis points.

Stehn highlighted that “inflation expectations have be lefted anchored, recent comments have signalled no appetite for stepping up the pace and the meeting will have no press colloquium or new projections.”

“We look for the MPC to retain its modal assessment that underlying inflation pressures will cool as headline inflation fall-offs but acknowledge the firmer recent data and note that risks to the inflation outlook remain skewed significantly to the upside. We also require the MPC to keep its loose forward guidance unchanged,” Stehn added.

Goldman Sachs expects the MPC to retain its relatively dovish postulate given resilient growth, sticky wage pressures and high core inflation, and to continue being pushed into diverse 25 basis point hikes by stronger-than-expected data, eventually reaching a terminal rate of 5.25% with jeopardizes skewed upside.

BNP Paribas economists also expect a 25 basis point hike on Thursday, as inflation expectations remnants lower than they were when the Bank was lifting rates in 50 basis point increments up to date year.

The French lender also upgraded its terminal rate forecast to 5.5% in a note last week, from 5% time past, in response to “clear evidence of more persistent inflation.”

Though the tightening cycle is expected to be longer than far up in order to reel in inflation, BNP Paribas suggested the MPC would be “wary of over-tightening” and will be looking to gauge how rate hills to date affect households, particularly as fixed-rate mortgage renewals roll in through the second and third quarter.

U.K. mortgage borrowers are being boosted to the brink as rising borrowing costs hit deal renewals and products are pulled from the market.

Laith Khalaf, direct of investment analysis at AJ Bell, said the MPC is “caught between a rock and a hard place” as it chooses between pushing numerous mortgage borrowers to a cliff edge and allowing inflation to run riot.

“Current interest rate pricing reflects daunt bells ringing in the market, but some moderation in inflationary pressures over the summer would pour balm on the state of affairs. The Bank of England will also be cognisant of the fact the full force of its tightening to date is still working its way into done with the economy,” Khalaf said.

“Having said that, should inflation data remain ugly, the Bank desire be under pressure to take action, and so will the Treasury, if it looks like the Prime Minister’s pledge to halve inflation is at endanger of falling short.”