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Why Is The BoE Interest Rate Decision On A Knife’s Edge?

The Bank of England (BoE) has a difficult decision ahead of it. Next week, on December 16, 2021, it must release its decision regarding its benchmark interest rate.

The two options on the table are for the Bank to increase its interest rate or leave it as is.

Why is the BoE interest rate decision on a knife’s edge?

Inflation in the UK is at a 10-year high

UK inflation BoE united-kingdom-inflation-cpi

Consumer prices in the UK have increased YoY by 4.2% up to October. Prices increased most in energy commodities such as gas and liquid fuels.

The BoE is tasked to keep inflation ~2% per annum. However, the BoE view is that inflation will return below 3% on average by the second quarter of 2022, and further downside movement in Q3 and Q4. This all means any intervention right now could turn out to be unnecessary or heavy-handed.

As it stands, the BoE’s benchmark interest rate is a historically low, 0.1%.

How long will ‘transitory’ UK inflation last?

The US Federal Reserve and the US Treasury figureheads have recently dumped the categorisation of inflation as “transitory”. However, the BoE hasn’t been pressured as much as the US institutions to drop the transitory line.

The BoE continues to hold out hope that the major drivers of inflation, such as energy prices, will subside by mid next year. The transitory nature of inflation, as the BoE see it, is concerning, as it means they run the risk of hiking interest rate before it is necessary.

Yet, no matter how transitory the high price of energy may turn out to be, the Bank of England’s hand may be forced by other matters, such as UK workers demanding much higher wages in response to the prolonged transitory inflation.

How possible is a wage-price spiral?

UK inflation BoE united-kingdom-wage-growth

UK workers are feeling the pinch of rising energy and consumer product and have been asking for wage increases to help mitigate the decrease in their disposable income.

Average weekly wages (including bonuses) in the UK have risen 5.8% YoY to September. The BoE has graded the wage growth for the UK as moderate and has dismissed the possibility of a “wage-price spiral”. Yet, if the major drivers of inflation do not abate in a reasonable amount of time, the BoE run the risk of inflation becoming entrenched as UK workers demand further pay rises.

Further exacerbating the issue is the tight labour market in the UK, with unemployment and under-employment currently at pre-pandemic lows, helping driving wage growth.

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