BoE faces ‘choice of poisons’ as inflation soars and banks collapse

Victoria Scholar discusses rise in interest rates

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The BoE’s rate-setting monetary policy committee (MPC) must choose between two courses of action, both of which could inflict serious damage on the nation’s economic health.

The first is to increase interest rates for the 11th successive meeting as it continues its battle against inflation, which would drive borrowing costs for consumers and businesses even higher.

The second is to freeze or even cut rates to stop the banking crisis from spiralling out of control. Unfortunately, this risks letting inflation rip.

Either could be lethal so which will poison will it choose?

Over the last year or so, Bank of England governor Andrew Bailey’s priority has been to keep a lid on consumer price growth.

The BoE has hiked rates from 0.1 percent in December 2021 to four percent at last month’s meeting, but the cost-living-crisis rages unchecked with inflation at a punishing 10.1 percent in January.

February’s figure is published tomorrow but is expected to be only slightly lower at 9.9 percent.

Chancellor Jeremy Hunt assured us all that inflation will fall to 2.9 percent by the end of the year but it’s far from a done deal. The BoE’s own forecasters reckon it will be four percent.

A couple of weeks ago, markets were convinced the BoE would hike base rates by another 0.25 percent on Thursday, lifting them to 4.25 percent.

Then the banking crisis struck and attitudes flipped.

The problem is that banks have become hooked on cheap finance and are suffering violent withdrawal symptoms.

Several have folded in the US, notably Silicon Valley Bank (SVB), while in Europe Swiss banking giant Credit Suisse has collapsed.

If central bankers continue to hike interest rates, more could fall as contagion spreads.

Last week, the European Central Bank lifted eurozone interest rates by 0.5 percent to three percent.

This Wednesday, we will see how the all-important US Federal Reserve responds.

Before SVB went bust, markets were expecting another 0.5 percent Fed increase from 4.75 percent to 5.25 percent. Now they’re not so sure.

The Bank of England’s decision is also hanging in the balance as its tough monetary medicine could prove more deadly than the disease.

Central bankers will find themselves at cross purposes if they are hiking interest rates while simultaneously throwing money at the big banks.

My best guess is that the MPC will stick to its guns and push through just one more rate hike of 0.25 percent.

Yet it will be a close call.

Two of its nine members, Silvana Tenreyro and Swati Dhingra, voted against February’s increase and are likely to push for a freeze this month, too.

They could argue that we need time to assess the impact of past hikes and the banking meltdown.

Other members will want to see clear evidence that inflation is beaten before easing.

Former MPC member David Blanchflower reckons the BoE is courting disaster and should slash rates to three percent right away to avoid driving the UK into a depression.

Whichever poison Bailey chooses, he’ll need a strong stomach and so do we.

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