Thu. May 19th, 2022

According to economists and traders in financial markets, the new Omicron variant of coronavirus has increased the likelihood that the Bank of England will hold back from raising interest rates this month.

Analysts expect a majority of members of the BoE’s Monetary Policy Committee at their December 16 meeting to decide they need more time to evaluate the implications of Omicron, and will vote to leave rates at the historic low of 0.1 percent .

Economists are uncertain about the BoE’s likely response to new information on Omicron after the central bank surprised markets by not raising rates in November, despite rising prices of goods and services. But many think the MPC will hold fire this month, even as the new variant is expected to increase inflationary pressures.

Yael Selfin, an economist at KPMG, said Omicron would increase uncertainties over the short-term economic outlook, causing the BoE to “hold back interest rate hikes this month”.

Robert Wood, an economist at Bank of America, said the BoE’s response to uncertainty about coronavirus and inflation had changed so much this year that the central bank was now “unpredictable”.

Line chart of CPI inflation with successive BoE 2021 forecasts (%) showing The BoE suggests that prices will not be stable if they leave rates unchanged

Unlike the US Federal Reserve, which has turned from boosting demand to tackling price growth, the BoE is focused on ensuring that the economic recovery remains strong amid what it sees as a temporary attack of high inflation, according to analysts.

Prudence was the watchword for a majority of MPC members, said Karen Ward, chief European market strategist at JPMorgan Asset Management. “The MPC is just not prepared to take any risks with the recovery, so the degree of conviction they need to move forward is much higher than normal,” she added.

Ruth Gregory, an economist at Capital Economics, a consulting firm, said Omicron was likely to increase inflationary pressures on goods and services by exacerbating supply chain disruption and discouraging people from working.

Nevertheless, she predicted that the MPC was unlikely to be able to withstand “the obvious temptation to wait” and persevere to raise interest rates until the outlook for coronavirus and the economy became clearer.

Traders also scaled down expectations for tighter monetary policy, which was fully included in the rates of overnight interest rate markets ahead of the MPC’s meeting on 4 November.

Now the forward interest rate for early January is just slightly above 0.1 percent, indicating a low expectation that monetary policy will be tightened by the BoE this month.

Line Graph of Forward Interest Rates in Overnight Exchange Rate Index (%) Showing Financial Markets Scaleed Expectations of Likely Interest Rate Increases

Far from all economists share the view that the MPC will leave interest rates unchanged at the December meeting, but the differences of opinion are mostly related to how the central bank is likely to react to new information about Omicron, rather than the economic or epidemiological outlook.

David Owen, founder of Saltmarsh Economics, a consulting firm, said he expected an end to quantitative easing by the BoE and a 0.15 percentage point rise in rates, adding the recovery was strong, inflationary pressures were much higher than expected, and Covid-19 vaccines would overtake Omicron.

Official data is unlikely to sway the MPC’s thinking at the December meeting, as it will all be linked to a period before Omicron became a cause for concern.

Labor market data since the end of the government’s leave scheme, once said by BoE officials as the crucial measure for a decision on interest rates, have been strong: the number of people employed in the UK has risen in October. Meanwhile, the October consumer price index rose 4.2 percent from a year earlier as inflation reached its highest level in nearly a decade.

Most economists expect the negative impact of Omicron on gross domestic product modest.

Graph showing subsequent coronavirus waves had a much smaller impact than the first on activity levels

“If Omicron had not been in discussion, I think we would have said that a December rate hike is not in doubt,” Ward said. “But if we want to be sure that the recovery will not be derailed by Omicron, the December meeting is much more uncertain.”

Private says some MPC members there is a difference in the evidence needed for a vote for an initial rate hike compared to any subsequent hikes because the first step sends a big signal and there is a bigger credibility issue than that must be reversed.

In public, however, MPC members have cautiously avoided making any commitment to rate hikes this month after sending signals before the November meeting that they are ready to tighten monetary policy.

Huw Pill, BoE chief economist and MPC member, said last week that the burden of proof had changed and he was looking for evidence that prevented him from voting for a rise, although he added that Omicron might just be the issue that remains his hand.

Michael Saunders, an outside MPC member who voted at the November meeting to tighten monetary policy, said last week there could be benefits to waiting for more information on Omicron before raising rates.

Some economists believe the outcome of the MPC’s December meeting is so uncertain that they deliberately avoided making precise predictions about future monetary policy.

Steffan Ball, an economist at Goldman Sachs, outlined several scenarios depending on the severity of Omicron, including the variant’s ability to escape vaccines and their transmissibility.

If Omicron was troubled, he said the BoE could wait until at least next May to tighten monetary policy, although its “basic scenario” was that the economy would hold up relatively well, and a rate hike was “more likely than not” in December.

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