Yesterday was not an especially good day for the Bank of England. As I pointed out several weeks ago it was clear that Governor Andrew Bailey thought that the move below would be his bazooka.
At its meeting ending on 3 August 2022, the MPC voted by a majority of 8-1 to increase Bank Rate by 0.5 percentage points, to 1.75%.
Unfortunately for him the world had moved on with the US moving by 0.75% twice and Canada by 1%. Even the ECB had moved by 0.5%. So the grand unveiling of the biggest interest-rate increase of the “independent” Bank of England era was greeted by markets with a shrug as it had become more of a peashooter.
Actually the Bank of England rather shot itself in the foot with its rhetoric.
CPI inflation is expected to rise more than forecast in the May Report, from 9.4% in June to just over 13% in 2022 Q4, and to remain at very elevated levels throughout much of 2023, before falling to the 2% target two years
ahead.
That was supposed to evoke images of the Bank being a doughty inflation fighter setting about its task. But with inflation forecast at 13% then interest-rates of 1.75% look most definitely like a peashooter.
In fact if we look at the rate of change the Bank of England has another problem. It may think that its 0.5% rise is major. But as the inflation peak has just risen by 2% then it has lost 1.5% in relative terms.
Inflation Forecasting by the Bank of England
Here is what it is telling us now.
Twelve-month CPI inflation had risen to 9.4% in June, 0.3 percentage points above the May Report projection……CPI inflation was expected to rise to around 10% in July and remain at around this level through the rest of the third quarter, reflecting higher fuel, food and services prices……In 2022 Q4, CPI inflation was expected to rise to just over 13%, about 3 percentage points higher than the expectation at the time of the May Report and more than 2 percentage points higher than at the time of the June MPC meeting.
As you can see even their own forecasts have been forced to admit the extent of their errors where they have got nothing right. Or if you prefer we know this because they are setting up a scapegoat.
The majority of that upside news was due to higher expected household energy prices. That primarily reflected the very substantial rise in wholesale gas futures prices that had occurred since the May Report, most recently due to Russia’s restrictions of gas supplies to European markets in July and due to the risk of further curbs. Since May, sterling gas futures prices for end-2022 had nearly doubled.
The problem with that is this
Bank of England CPI inflation ‘peak’ forecasts*:
Nov 21: “peaking at around 5% in April 22”
Feb 22: “peaking at around 7.25% in April 22”
May 22: “may rise to in excess of 10% towards the end of the year”
Aug 22: “just over 13% in 2022 Q4” (* % y/y change) ( @MichaelGoodwell )
I see a media narrative developing that is reinforcing the Bank of England view. Cynics would say that is because they too pushed the “inflation is transitory” line. But if we stick to the facts UK CPI inflation reached 5% ( in fact 5.1%) last November just as the Bank of England was assuring us it would not get their until April. It then passed 6% in February.
How much more wrong could Chief Economist Huw Pill have been on the 26th of November? The emphasis is mine.
In large part, I agreed with the Bank’s published analysis that argued that the bulk of the above-target inflation anticipated from September would prove transitory. I believed that the uncomfortably high inflation rates we will face in the coming months mainly reflected temporary factors, such as the pandemic-driven supply bottlenecks I discussed earlier, which are likely to ease as the health situation improves.
My starting point was that monetary policy should largely ‘look through’ these effects.
He was already wrong as the November inflation figures proved. Since then it has gone from bad to worse. Yes the Russian invasion of Ukraine has made things worse but we already were in a vulnerable situation with inflation heading to treble its target.
Inflation is being under recorded
This issue is being missed completely and let me explain why. Inflation calculations use a weight for expected spending and they are adjusted each year which with the delays of measurement and so on mean they are usually around 2 years behind. But expenditure on domestic energy has soared as the Bank of England explains below.
The direct contribution of energy to CPI inflation was projected to reach 6½ percentage points in 2022 Q4, nearly 2½ percentage points higher than in the May Report and expected to account for more than half of the overshoot of CPI inflation relative to the 2% target. The rise in energy prices was likely to have additional indirect effects on CPI inflation by increasing firms’ costs, which were then likely to be passed on to a wide range of prices for non-energy goods and services. Bank staff estimated that these indirect effects would contribute around 1 percentage point to CPI inflation in 2022 Q4.
So people will be spending much more on energy than when the inflation weights were calculated. If we look at what they are we see a familiar situation.
RPI 4.8%
CPI 3.3%
CPIH 3.1%
The “discredited” and “not a national statistic” RPI is reflecting reality much more accurately than the other measures. As it turns out even it is too low as households will be spending much more on energy this year. Perhaps a weight of 7.5% would have been realistic and that is the way inflation has been under-recorded as the increases have been factored into inflation with too low a weight.
The statisticians are trying their best as the main problem is that events have moved too fast for them. But more sophisticated analysis should allow for this. Now tell me where you see anyone else pointing this out? The Bank of England should be but it only makes its own position worse.
Recession?
Regular readers know my views on stagflation risks but let me point out another issue with the Bank of England.
Monthly GDP was estimated to have increased by 0.5% in May, following a 0.2% decline in April. The May outturn had been weaker than Bank staff had expected,
May was weaker than expected,really?
Comment
Let me first hand you over to the absent-minded professor.
UK BOE DEP. GOV. BROADBENT: TO FULLY OFFSET CURRENT INFLATION, WE WOULD HAVE NEEDED TO RAISE INTEREST RATES BY DOUBLE DIGITS LAST YEAR, RESULTING IN A MUCH DEEPER RECESSION THAN IS NOW PREDICTED. ( @financialjuice )
This is extreme even for a straw(wo)man effort. The reality is that he was busy making things worse as I pointed out last August.
The Bank of England has bought another £1.15 billion of UK bonds this afternoon as part of its QE operations. The problems are
1. Inflation is above target
2. Look at what bond yields are ( August 4th 2021)
And from September 21st last year.
The Bank of England has just bought another £1.15 billion of UK bonds as part of its QE operation to push inflation above target. ( Yes I know it is already above target so tell them not me please)
So Ben Broadbent and his colleagues were actively pushing inflation higher when I was arguing to take the stimulus away ( stop QE and put interest-rates back to 0.75% as an initial move). Which do you think looks best now?
The problem that Ben and the other 8 policymakers have now is that they have been so wrong markets mostly ignore them. They have increased interest-rates to 1.75% with the implication that there will be more rises on their way. The UK five-year yield is 1.73% and says we may get another rise or 2 but we are expecting cuts shortly afterwards.
Also there was a potential new phase of QT announced yesterday which I will cover in today’s podcast.