MUFG: BoE will await February before raising interest rates, and rightly so

December 14, 2021

This is a commentary by MUFG Economist Henry Cook ahead of the Bank of England's interest rate decision.

After the November meeting it seemed that the BoE would hike at the next opportunity unless there was a rise in unemployment following the end of the furlough scheme. Today’s labour market release showed the opposite with the headline unemployment rate continuing to fall in October. 

After it was noted that “it would be necessary over coming months to increase Bank Rate” last time around we feel that the MPC would surely have voted to hike rates at this meeting following this week’s encouraging jobs data but the emergence of the Omicron variant has thrown a spanner in the works. While the government has not imposed any major restrictions, factors such as the shift to home working and individuals voluntarily limiting social contact are set to drag on economic activity into 2022. There is a chance that the government will have to go further with restrictions (perhaps with a focus on customer-facing services) if hospitalisations were to start to increase rapidly.

While the effect of restrictions on the economy has weakened over time as measures become much more targeted, we know that any COVID restrictions remain hugely significant for GDP figures. If Omicron compounds the seasonal spread of COVID to the extent that tight restrictions are required then GDP, which is now on the cusp of its pre-pandemic level, would likely slip back again.

At the same time, the emergence of Omicron could lead to higher inflation for longer. Global supply bottlenecks had been showing some signs of easing but these could increase again if Omicron leads to factory closures and worker absence. There could also be a rotation from services consumption (such as bars and restaurants) back towards goods, which are more sensitive to supply-chain problems and have shown considerably higher rates of inflation in recent months.

So, potentially lower growth and more persistent inflation, at least over the short-term. The emergence of the Omicron variant is not going to help ease any stagflation fears and will be a headache for policymakers. The BoE will (rightfully) be cautious while we wait for a clearer understanding around this next stage of the pandemic and any policy changes at this meeting have become very unlikely. We still expect rate hikes next year – starting as soon as February if the Omicron situation proves to be benign. But if it does prove to be another tough winter then even the chances of a hike in February would start to diminish.

The good news is that the UK economy has shown that it can bounce back quickly from any restrictions. Monthly GDP is now just 0.5% below its pre-pandemic level and the macroeconomic impact of COVID waves has diminished each time as measures have become more targeted and households and businesses have learnt how to adjust. We see no reason at this stage to assume that another round of COVID restrictions, even if implemented, would increase the degree of economic scarring over the long-term. Expect a similar message from the BoE – Omicron uncertainty may delay the first move but higher rates in 2022 are still very much on the cards.