Bank of England hikes interest rates for first time in pandemic era

The Bank of England, on Thursday, 16 December, in its terminal Monetary Policy Committee (MPC) meeting for 2021, raised the key lending rates by 15 basis points, surprising everyone as it is the first major central bank to raise the interest rates among the US Federal Reserve, the European Central Bank and the Bank of Japan.

The ever-evolving worries of higher rate of inflation has seemingly steered the decision to raise the interest rates with the central bank’s Committee members setting the monetary policy that can help in achieving the pre-estimated inflation target of 2%. Before the present quarter, every major central bank said the inflationary hurdles are likely to be short-lived.

But the persisting operative challenges including the faltering supply chains, delayed orders, market-wide shortages of workers, companies encountering severe difficulties in rehiring or deploying the adequate number of people even with the vacancies hovering at record levels, limitedness of raw materials and some essential components such as the semiconductor chips, have collectively pushed the rate of inflation to multi-year highs with the United States inflation hitting a 39-year high and UK CPI based inflation reaching a fresh decade-high.

The Bank of England’s nine-member MPC voted 8-1 in favour of increasing the bank rate by 0.15 percentage points to 0.25% from the record low levels of 0.10% at the meeting ended on Wednesday, 15 December 2021. However, the Committee voted unanimously to maintain the bond buying programme at £875 billion.

Eight members including the Bank of England’s Governor Andrew Bailey, alongside Ben Broadbent, Jon Cunliffe, Michael Saunders, Huw Pill, Catherine L Mann, Jonathan Haskel and Dave Ramsden voted in favour of raising the interest rates for the first time in the 21-month long pandemic era, while Silvana Tenreyro voted against the proposition to hike bank rate, she preferred to maintaining the rates at record low of 0.1%.

According to the nine-member Committee chaired by the Bank of England Governor Andrew Bailey, the national economic output of the United Kingdom, as well as the cumulative output on a global scale is expected to recover further in the upcoming months from the pandemic-led downturn as industries remain on the track of continuous improvement.

As per the estimates by the Bank of England, the rate of inflation is projected to moderate in the second half of 2022 as global central banks are poised to raise the key lending rates in the upcoming meetings, alongside revealing the material plans for tapering the bond purchases.

These factors coupled with the improvement in supply chain and logistics functions, rebalancing of global demand from goods to services following the wider reopening of international borders and stabilising energy prices are highly likely to dissipate the upward pressure on the CPI inflation over a period of time.

Given the renewed uncertainty following the emergence of the Omicron variant and the rapidly increasing infection across the United Kingdom, in other European countries and the rest of the world, the apparent time period of complete recovery will certainly extend. The central bank’s MPC has concluded that a moderate increase of 15 basis points is justified in the meeting ended 15 December. .

With the higher transmissibility of the Omicron variant as compared to the previously popular Delta variant, chances of unforeseen risks, and large number of outbreaks with the new strain set to become the dominant variant in the UK in a matter of days, the yields of long-term government-backed bonds have sharply fallen in the last few sessions as investors turn skeptical about the extent of damage.

The new variant has categorically disturbed the healthcare authorities, the vaccine makers and the biotech corporations working on introducing therapeutic treatments that can be more effective against Covid-19 (SARS-CoV-2) virus, as the new strain continues to override the so-called highest possible protection obtained from completing the two-dose regimen of Covid-19 vaccine.

Of the total confirmed cases reported in the UK so far, a large section of individuals have been infected with the virus even after receiving both the jabs on time. As the pandemic activity continues to handhold the key economic, as well as market functions, the scope and extent of Omicron variant will certainly affect the operations, cross-border trade, internal movement as some governments reimpose the pandemic restrictions, while others examine the situation to reintroducing mini lockdowns or some of the reciprocatory measures that can help in containing the spread of virus.

The Bank of England’s MPC believes that the level of global GDP in the fourth quarter of 2021 is likely to remain broadly in-line according to the November report, while the Committee has revised its projections for the UK GDP for the corresponding period. In the October-December period of 2021, the level of UK GDP has been revised by 0.50%, effectively leaving the national economic output 1.5% lower as against the pre-Covid levels.

On the contrary, the consumer price inflation in almost all the advanced economies across the world have surged heavily, potentially increasing the procurement costs for businesses, as a result of which they are increasingly passing on the burden of high costs to the consumers. Due to the emerging course of the Omicron variant, the Committee has said that the aftereffect of sharp resurgence in cases linked to new variant on “medium-term global inflationary pressures” is unclear.

The reintroduction of the mask mandate by the Downing Street administration following the arrival of Omicron variant, the UK GDP is likely to witness a moderate contraction in the months of December 2021 and January 2022, as the existential difficulties including the disrupted supply chains and dearth of human capital continue prohibit a meaningful growth in many sectors. Among the worst affected sectors, the hardships of consumer-facing businesses, enterprises operating within the hospitality industry and mainly the services sector have certainly increased due to the Omicron variant.

The rate of unemployment sliding to the lowest level since June of 2020 categorically indicates that the employment activity has been unaffected by the discontinuation of furlough scheme, as the number of payrolled employees continue to rise strongly in November of 2021.

The Bank of England believes that the rate of inflation is likely to peak at around 6% in April of 2022, after hovering around 5% during most of the winter period. Further increases in the CPI rate of inflation can be seen, if the utility bills continue to rise following exceptional upward movements in the crude oil and gas prices.