The Bank of England (BoE) has consistently underestimated UK inflation in the past 18 months. The central bank barely acknowledged that the pandemic would have any impact on prices back in May 2021 (gray line above), and none of its subsequent forecasts in August 2021, November 2021, February 2022, and May 2022 have aged much better.
That might be because the BoE originally claimed inflation was “transitory” – the result of a sharp pandemic-induced slowdown in production and shipping that would pass once everything was up and running again. So in order not to risk the post-pandemic economic recovery, the central bank was reluctant to hike interest rates for no good reason. It was only when it became inarguable in December 2021 that inflation wasn’t just a blip that the BoE started raising rates, culminating in yesterday’s 0.5 percentage point hike – the biggest since 1995.
That 27-year record came as the BoE admitted that it’s now expecting inflation to peak at 13.3% in October (green line), and that it doesn’t think inflation will fall back to the central bank’s long-standing target of 2% until 2024. The central bank seemed to acknowledge that its own slow-and-steady approach had backfired too: it thinks a recession – which it predicts will arrive in the fourth quarter and last the whole of next year – will have more of an impact than rate hikes on bringing down inflation at this point.
That’s important. See, the British pound should theoretically perform well in a higher-rate environment, as it becomes more appealing to international savers and investors. But the uncertainty of a recession will outweigh any of those benefits, which could mean sterling’s in for one heck of a ride…
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