Within the Bank of England's policy committee, a clear divide is forming. One member is advocating for a prompt increase in interest rates, while the Governor suggests there is no immediate rush, highlighting the complex economic landscape the central bank must navigate.
Megan Greene's Hawkish Stance
Policy maker Megan Greene has indicated that the case for raising interest rates is strengthening as the conflict in the Middle East persists. This suggests more officials may soon join Chief Economist Huw Pill in calling for action to curb inflation. As one of the more hawkish members of the Monetary Policy Committee (MPC), Greene argued that it may be necessary to raise borrowing costs soon to prevent inflation expectations from becoming unanchored. She emphasized that the speed of action is as crucial as the magnitude of rate hikes when confronting inflationary threats.
Speaking at the University of Derby Business School, Greene stated, "I think the case for raising rates is strengthening as the conflict goes on. I believe it may be necessary to tighten monetary policy in the coming weeks or months." The MPC's next interest rate decision is scheduled for June 18th. While only Pill supported an immediate hike in April, several officials, including Greene, have indicated they would consider supporting a rate increase if the war continues.
Reports of a potential deal between the US and Iran are unlikely to provide a permanent solution to the conflict. Furthermore, damaged energy infrastructure in the region will take time to rebuild, delaying the full restoration of oil and gas supplies. Concurrently, with household and business energy bills rising, UK inflation is expected to approach 4% later this year. Money markets have now fully priced in a 25-basis-point rate hike by the Bank of England in September, with an 85% probability of another hike before year-end.
Risks of Second-Round Inflation Effects
Greene warned that macroeconomic impacts would persist over the next year even if the conflict ended immediately. She suggested the second-round effects on inflation could fall somewhere between the relatively mild impact of the 2011 energy price spike and the more severe gas crisis following Russia's invasion of Ukraine in 2022.
Greene added that a more likely scenario is businesses passing on higher costs to consumers, rather than workers demanding higher wages to compensate for inflation. Notably, she had previously warned that inflation risks were "skewed entirely to the upside." While acknowledging it was worth waiting to see how the Middle East conflict develops before deciding on rates, she stressed that upside inflation risks had created a "ratchet effect," with risks to energy prices and second-round effects skewed upward.
She noted that the UK's weak economy and loose labor market should help limit second-round price effects from a global energy shock. However, she admitted that progress in fighting inflation had already stalled before the conflict began. "We are now facing a negative supply shock, an energy shock, which will push inflation up and drag growth down. This is a very bad situation for a central bank," Greene said. In April, she voted with the majority of the nine-member committee to hold rates steady, stating the Bank should not rely on financial markets to tighten conditions and "do the work for us."
Governor Andrew Bailey's Contrasting View
Greene's comments stand in sharp contrast to those of Governor Andrew Bailey. While Greene was speaking, Bailey was testifying before the House of Lords Economic Affairs Committee. Bailey stated, "I think we actually have a bit more time, particularly because the fact is our policy is restrictive." He hinted he was in no rush for an immediate rate hike, given that the energy shock has made the demand outlook more fragile.
This indicates the MPC may soon re-split into the two camps that existed before the Middle East conflict erupted. The difference is that the previous debate focused on the pace of rate cuts, whereas officials are now weighing how to balance curbing a potential inflation spike with supporting a weak UK economy.
Other Committee Perspectives
MPC member Alan Taylor also suggested that a UK rate hike would only be truly warranted under the most pessimistic Middle East scenario. He warned the conflict is increasing the risk of the UK economy falling into recession. He pointed out that the currently weak labor market is suppressing price pressures, making a repeat of the 2022 wage-price spiral relatively less likely.
Taylor, who also voted to hold rates in April, said, "The UK economy is very weak at the moment and is being hit by an inflationary supply shock, which puts us in a very complicated trade-off. Given that monetary policy is already quite restrictive, we don't need to react overly aggressively."
Broader Economic Challenges
Governor Bailey also warned of dual challenges facing the UK economy: an aging population and a growing number of young people who are neither working nor in education. "If you have an aging population and a falling participation rate among the young at the same time, then that is a more concerning picture," Bailey said. "If you have both of those things happening, I think that is a very, very significant issue and a very serious issue."
Bailey's remarks come amid growing government concern that the number of young people not in education, employment, or training (NEETs) has surpassed one million for the first time in over a decade. There are market fears that youth unemployment could have long-term negative effects on careers, drag on economic growth and tax revenues, and further increase already high social welfare spending.
Trade Policy Considerations
In a separate event, MPC member Swati Dingra suggested that as global trade frictions intensify, the UK will have to move closer to the European Union in the future. Speaking at an event, she stated, "Typically, when there is a trade war, if you are a medium-sized economy, you have to choose to get closer to a large economic partner." She added, "In my view, in the current environment, who is the most reliable trade partner? The EU is clearly the most promising candidate."
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