Bank of England May Be Wary of Looking Past Another Energy Shock

Later this week, Bank of England policymakers will receive their first briefings as preparations for the March 19 interest-rate decision get under way. The question is how far they are willing to tolerate an energy-price shock that is threatening to blow inflation off course.Author of the article:You can save this article by registering for free here. Or sign-in if you have an account.(Bloomberg) — Later this week, Bank of England policymakers will receive their first briefings as preparations for the March 19 interest-rate decision get under way. The question is how far they are willing to tolerate an energy-price shock that is threatening to blow inflation off course.Subscribe now to read the latest news in your city and across Canada.Subscribe now to read the latest news in your city and across Canada.Create an account or sign in to continue with your reading experience.Create an account or sign in to continue with your reading experience.An economics textbook approach would treat it as a temporary blip, as the UK central bank did in the early 2010s when energy prices briefly drove inflation above 5%. However, some believe a rewrite is needed after rate-setters struggled to contain the fallout from a leap in energy prices following Russia’s invasion of Ukraine four years ago.“The old mantra that central banks are likely to look through the inflationary effects of energy-price shocks no longer applies, at least not everywhere,” said Michael Saunders, senior advisor at Oxford Economics and a former BOE rate-setter. “If the surge in energy prices persists or expands, the Monetary Policy Committee will be set for an extended pause.”Get the latest headlines, breaking news and columns.By signing up you consent to receive the above newsletter from Postmedia Network Inc.A welcome email is on its way. If you don't see it, please check your junk folder.The next issue of Top Stories will soon be in your inbox.We encountered an issue signing you up. Please try againInterested in more newsletters? Browse here.Markets are all but ruling out a rate cut this month that had looked like a done deal prior to the war on Iran, and traders now put the chance of any easing at all this year at around 50-50.

The National Institute of Economic and Social Research says rates may need to rise back above 4% if the shock persists. Before the US and Israel launched their attack on Feb. 28, the BOE expected inflation to hit its 2% target in the spring as government measures to help with the cost of living kicked in. Economists had predicted one or two more rate cuts from the current level of 3.75%. But the surge in energy prices since then could result in inflation returning to around 3.5% later this year if the moves stick, according to ING. Brent crude gained over 27% last week as the conflict unleashed a wave of disruption across energy markets, with shipping through the Strait of Hormuz at a near-total halt.The shift in rate bets is a blow to Chancellor of the Exchequer Rachel Reeves, who was counting on cheaper borrowing to boost the economy and help contain the huge cost of servicing Britain’s £3 trillion ($4 trillion) debt mountain. Gilts plunged last week, adding 40 basis points to the yield on 10-year securities.The risk is that the price shock rekindles inflation expectations that then fuel wage demands, a problem the BOE has struggled with more than the European Central Bank and Federal Reserve.

Governor Andrew Bailey will likely want to avoid fresh accusations of complacency, after the bank was criticized for its response to the post-pandemic supply-chain squeeze in 2021 and the invasion of Ukraine the following year.Some economists, however, argue wagers have moved too far and that the scale of disruption is not enough to shift the dial for the BOE with the energy market not facing that sort of structural upheaval caused by the war in Ukraine. On the domestic front, growth is weak with unemployment at a five-year high, and that’s subduing home-grown price pressures.“I continue to think that the Bank of England will cut more than expected, maybe they delay the cut,” said Samy Chaar, chief economist at Lombard Odier. “But in the end, what I think matters for the rate outlook in the UK, in Europe and the US, is the sources of domestic inflation… Wages are coming down. Labor markets are wobbly.”Indeed, Alan Taylor, a prominent dove on the MPC, has suggested rate-setters should not overreact. While refusing to be drawn on the policy implications of the Iran war during an appearance in Norway on Monday, he said the BOE’s mandate “urges us to look through those one-off shocks.” Tighter financial conditions are arguably already doing some of the work. Some lenders are now raising mortgage rates including HSBC and Nationwide after swap rates that are used to price the loans moved higher on expectations of fewer reductions by the BOE.Inflation expectations that remain too high for comfort will be the main concern of BOE officials who have been bringing down borrowing costs in cautious steps since the summer of 2024.Britons were quick to respond to a jump in energy and food bills last year — particularly salient parts of the inflation basket for consumers. Households still expect prices to rise 3.5% over the next 12 months, according to polling for the BOE, while the pace of wage growth anticipated by firms remains above levels consistent with 2% inflation. “The experience of recent years suggests that inflation expectations and pay deals are highly sensitive to higher CPI inflation,” said Saunders.Sanjay Raja, chief UK economist at Deutsche Bank, also sees reasons for concern, estimating that around half of the inflation basket now has a high energy intensity — a share that has only increased in recent years.“If held, such moves would disrupt the UK’s disinflation track meaningfully, and raise concerns of second-round effects next year, including sticky inflation expectations,” he said on the rise in energy prices. “This could buoy wage settlements in the coming year, putting in doubt both the pace and scale of rate cuts.”Postmedia is committed to maintaining a lively but civil forum for discussion. Please keep comments relevant and respectful. Comments may take up to an hour to appear on the site. You will receive an email if there is a reply to your comment, an update to a thread you follow or if a user you follow comments. Visit our Community Guidelines for more information.