BoE unlikely to raise interest rates this month, say economists

The new Omicron variant of coronavirus has increased the likelihood of the Bank of England holding back from raising interest rates this month, according to economists and traders in financial markets.

Analysts expect a majority of members of the BoE’s Monetary Policy Committee to decide at their meeting on December 16 that they need more time to evaluate the implications of Omicron, and will vote to leave rates on hold at the historic low of 0.1 per cent.

Economists are unsure about the BoE’s likely response to new information about Omicron after the central bank surprised markets by not raising rates in November, despite surging prices of goods and services. But many think the MPC will hold fire this month even if the new variant is expected to increase inflationary pressures.

Yael Selfin, economist at KPMG, said Omicron would increase uncertainties over the short-term economic outlook, causing the BoE to “hold off raising interest rates this month”.

Robert Wood, economist at Bank of America, said the BoE’s reaction to coronavirus uncertainty and inflation had chopped and changed so much this year the central bank was now “unpredictable”.

Line chart of CPI inflation with successive BoE 2021 forecasts (%) showing The BoE suggests prices will not be stable if it leaves rates unchanged

Unlike the US Federal Reserve, which has pivoted from boosting demand to tackling price growth, the BoE is focused on ensuring the economic recovery remains strong amid what it sees as a temporary bout of high inflation, according to analysts.

Caution was the watchword for a majority of MPC members, said Karen Ward, chief European market strategist at JPMorgan Asset Management. “The MPC is just not willing to take any risks with the recovery, so the degree of conviction they need to move forward is much higher than normal,” she added.

Ruth Gregory, economist at Capital Economics, a consultancy, said Omicron was likely to raise inflationary pressures on goods and services by aggravating supply chain disruptions and discouraging people from working.

Even so, she predicted the MPC was unlikely to be able to resist “the clear temptation to wait”, and hold off on raising interest rates, until the outlook for coronavirus and the economy was clearer.

Traders have also scaled back expectations for tighter monetary policy, which was fully included in the prices of overnight interest rate markets before the MPC’s November 4 meeting.

Now the forward interest rate for early January is only a little higher than 0.1 per cent, indicating a low expectation of monetary policy being tightened by the BoE this month.

Line chart of Forward interest rates in Overnight Index Swap market (%) showing Financial markets have scaled back expectations of likely interest rate rises

Far from all economists share the view the MPC will leave interest rates unchanged at the December meeting, but the disagreements relate mostly to how the central bank is likely to respond to new information about Omicron, rather than the economic or epidemiological outlook.

David Owen, founder of Saltmarsh Economics, a consultancy, said he expected an end to quantitative easing by the BoE and a 0.15 percentage point rise in rates, adding the recovery had been strong, inflationary pressures were much higher than expected, and Covid-19 vaccines would catch up with Omicron.

Official data is unlikely to sway the MPC’s thinking at the December meeting, since it will all relate to a period before Omicron had become a cause for concern.

Labour market data since the end of the government’s furlough scheme, once said by BoE officials to be the pivotal metric for a decision on interest rates, has been strong: the number of people employed in the UK rose in October. Meanwhile, the October consumer price index rose 4.2 per cent from one year earlier, as inflation reached its highest level in almost a decade.

Most economists expect the negative impact of Omicron on gross domestic product to be modest.

Chart showing Subsequent coronavirus waves have had a much smaller impact than the first on levels of activity

“If Omicron wasn’t in discussion, I think we’d be saying that a December rate rise wasn’t in doubt,” said Ward. “But if we’re looking to be sure the recovery won’t be derailed by Omicron, the December meeting is much more uncertain.”

Privately, some MPC members say there is a difference in the evidence required for a vote for an initial rate rise compared with any subsequent increases because the first move sends a big signal and there is a higher credibility issue if it needs to be reversed.

In public, however, MPC members have carefully avoided making any commitment to raising rates this month after having sent signals before the November meeting that they were poised to tighten monetary policy.

Huw Pill, BoE chief economist and MPC member, last week said the burden of proof had changed and he was looking for evidence preventing him from voting for a rise, although he added that Omicron might just be the issue that stayed his hand.

Michael Saunders, an external MPC member who voted to tighten monetary policy at the November meeting, said last week there could be advantages in waiting for more information about Omicron before raising rates.

Some economists think the outcome of the MPC’s December meeting is so uncertain that they have deliberately avoided making precise predictions about future monetary policy.

Steffan Ball, economist at Goldman Sachs, outlined several scenarios depending on the severity of Omicron, including the variant’s ability to escape vaccines and its transmissibility.

If Omicron was troublesome, he said the BoE could wait until at least next May to tighten monetary policy, although his “baseline scenario” was that the economy would hold up relatively well, and a rate rise was “more likely than not” in December.


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