Bank hikes rates by 0.25 per cent but next MPC decision won’t be so easy

Inflation is still far too high and core inflation is proving worryingly hard to shift

There may be more pain to come for small businesses and home buyers (Getty/iStock)

Central bankers are careful with words because they are closely watched and acted upon by the markets, the views of which they help to inform. So you won’t see words such as “earthquake” or “crisis” or “horror show” in the Monetary Policy Committee’s minutes even if that’s what it has felt like we’ve been living through in recent weeks.

In just the last seven days, authorities have put together a rescue for Credit Suisse, one of the world’s largest and systematically significant banks, averting a full-blown crisis but creating a nasty rumble in the bond markets because of the way it was put together; the US Federal Reserve raised its rates by a quarter-point; and Britain’s inflation unexpectedly shot back up to 10.4 per cent when forecasters had been predicting a single-digit figure.

“There had been large and volatile moves in financial markets since the MPC’s previous meeting,” was how the Bank of England’s rate-setting committee described it.

The MPC faced a tough decision, said commentators. Really? At the beginning of the week I predicted a quarter-point rise to 4.25 per cent and a 7-2 vote, before some of the above had happened. That was exactly how it turned out.

The pathway was fairly clear this time around. The identity of its pair of dissenting doves, Swati Dhingra and Silvana Tenreyro, also came as no surprise; the have long made the case for a pause in rate rises.

Their arguments were buttressed by the turbulence that has emerged in the banking sector, a consequence of rapidly-rising interest rates around the world and the negative impact this has had on bond portfolios at weaker institutions.

They could also point to the Bank’s continuing view that UK inflation will fall fast and “to a lower rate than anticipated last month” in the current quarter. That is partly down to chancellor Jeremy Hunt’s sensible decision to maintain energy price support for consumers at a level at which average annual bills would come out at £2,500 rather than the planned £3,000.

Those bills should fall further in the second part of the year, as a result of the market rather than government action. This will apply a sharper set of shears to the consumer prices index.

But the remainder of the MPC is rightly concerned about Britain’s stubbornly sticky core inflation, a measure which strips out volatile components such as energy and food and which also unexpectedly rose in February. It has proved stubborn elsewhere too.

The economy is doing better than expected, with the Bank no longer forecasting a decline in the second quarter. Fears of a recession of record breaking length this year have evaporated. The MPC now doesn’t expect to see any recession (to meet the technical criteria the economy would have to decline over two consecutive quarters). Unemployment isn’t expected to rise by much either, potentially exerting upward pressure on wages, although wage rises have lately been soft.

We shouldn’t forget that food price inflation, which is running at a record 18 per cent. The current inflationary surge is kicking the poorest hardest.

The MPC’s decision, following hot on the heels of the Fed’s 0.25 per cent hike in the US, was as important as a statement of intent as it was for the dampening effect it will hopefully have on the inflation plaguing the UK.

Pains were taken to stress the “resilience” of the UK banking system. Nerves have been jangling, given the financial sector’s importance to Britain’s economy. But the banks on these shores are much better capitalised than they were. All those loopy scenarios dreamed up by the Bank during stress-testing exercises? They don’t seem so wild now.

However, while the pathway for the MPC might have been fairly obvious this time around, it is unlikely to be the case next time and even less so further down the line.

Smaller business are gnashing their teeth after being given the brush-off by the chancellor in the Budget. “Interest rate rise must be the last,” thundered the Federation of Small Businesses. Hear hear, cry homebuyers perusing the mortgage market.

But there may be more pain to come. The City expects another 0.25 point rise, with a peak of 4.5 per cent. Expectations for that have risen somewhat. It is hard medicine but inflation is running at five times the Bank’s target and it simply has to be brought back under control.