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The Hits Keep Coming

Last Thursday, the Bank of England announced its 11th consecutive quarter-point interest rate increase. This move came on the heels of data released on Wednesday that revealed an unexpected increase in Britain’s inflation rate. Consumer prices rose to 10.4 per cent in February, up from 10.1 per cent in the previous month, ending a downward trend and keeping inflation stubbornly in the double digits.

Despite these developments, the central bank has affirmed that Britain’s banking system is “resilient” and can withstand a period of higher interest rates, according to minutes from this week’s meeting. This policy decision coincides with a period of increasing tension for central banks, with turmoil in the US banking system creating the sense that policymakers are battling two opposing risks: inflation that will remain persistent and need to be tackled with higher interest rates, and higher rates that could worsen banking turmoil.
Earlier on Thursday, the Swiss National Bank also raised interest rates by half a percentage point to counter the “renewed increase in inflationary pressures” in Switzerland. This decision came days after one of the country’s largest banks, Credit Suisse, was bought by UBS, its larger rival, in a deal hastily brokered by the government to stem a growing banking crisis. The Swiss central bank has stated that it is “providing large amounts of liquidity assistance” in Swiss francs and foreign currency.

Missed Targets

The Bank of England’s policymakers have raised interest rates to 4.25 per cent since December 2021, up from near zero, in an effort to stamp out high inflation. Last month, the bank indicated that future interest rate increases were not a given, and policymakers would respond to signs of inflation being embedded in the economy. This led analysts to expect the bank was close to halting rate increases, a sentiment that was reiterated this week.

The Bank of England has forecast that the inflation rate will fall significantly this year, averaging about 4 per cent around the end of the year. Inflation is expected to fall more than anticipated in the second quarter of this year due to the government’s decision to extend its subsidy for household energy bills for an additional three months until the end of June. Additionally, wage growth has been weaker than expected, easing policymakers’ concerns that high wages in the private sector would make it harder to return inflation to the bank’s 2 per cent target.

Andrew Bailey, the governor of the central bank, said after last month’s meeting that there had been a “turning of the corner” on inflation, but warned that “it’s very early days, and the risks are very large.” Some of these risks materialized in Wednesday’s data, which showed food prices rising in February at their fastest pace in 45 years, and a measure of services inflation increasing. This week’s meeting demonstrated the challenge the bank faces in determining the path of inflation.

The increase in inflation was 0.6 percentage points higher last month than the central bank expected and came from rising food prices and higher prices for goods, namely clothing and footwear. According to the minutes of the bank’s meeting, those prices “tend to be volatile and could therefore prove less persistent.” However, there was some hesitancy over this assessment, with some policymakers wondering whether the surprise in inflation was simply a one-off or whether some aspects of inflation were being driven higher by other, less clear, underlying factors. Seven of the bank’s nine policymakers voted to raise rates because they believed it was possible that the economy was stronger than expected, driven by more demand rather than the benefits of lower energy prices.