(Alliance News) - Bank of England Governor Andrew Bailey on Thursday said what Threadneedle Street does next "will depend on the size and duration of shock to energy prices".
The governor cautioned that there is little monetary policy can do to stop energy prices running wild and hitting the UK economy and inflation.
The BoE's Monetary Policy Committee voted 8-1 to leave bank rate on hold at 3.75%. BoE Chief Economist Huw Pill put the case for a quarter point rate increase to 4.0%.
The BoE laid out three scenarios for the UK's economic outlook as it assesses options for monetary policy amid the Middle East crisis and energy price shock.
In its April monetary policy report, the BoE said the scenarios help to illustrate a range of possible outcomes for the UK economy and weigh differing paths for energy prices and the extent of any second-round effects on domestic price and wage-setting.
Across these three scenarios, inflation is higher in the near term than the central projection in the BoE's February report.
"Where we go from here will depend on the size and duration of shock to energy prices," Bailey told a press conference after the decision.
Much hinges on second round effects, though these can be uncertain, Bailey said.
Second round effects could particularly be felt in food, the governor cautioned. Not only is food production energy-intensive, it is also exposed to fertiliser costs.
But despite the potential uncertainty, Bailey warned it would be risky to wait too long for second round effects before acting. However, he described Thursday's hold as an "active" one and not a "passive, wait-and-see" one.
The BoE in its February projections forecast consumer price inflation to return to the 2% target this year and remain around that rate in the medium term. But under
But on Thursday, the BoE said larger and more persistent rises in global energy prices are judged to be likely to lead to bigger second-round effects on inflation. In its worst-case scenario, the BoE sees consumer price inflation peaking at 6.2% next year, though not at the double-digit levels seen in 2022, it would still be markedly above the 2% target.
Under scenario A oil peaks at USD108 per barrel this year before falling to below USD80 per barrel by 2027 first quarter. In B, the oil price hits the same peak but remains elevated for longer, while in C, the oil price soars to USD130 per barrel.
Scenario A sees inflation peaking at 3.6% at the end of this year and scenario B 3.7%. Data earlier in April showed UK annual consumer price inflation accelerated to 3.3% in March from 3.0% in February.
Bailey said he places most weight on scenario B, albeit with slightly reduced second-round effects.
"I place some weight on scenario C, which would require a stronger monetary policy response. For now, the softer real economy makes it appropriate to maintain bank rate," he said in the decision statement.
During the press conference, he said volatility makes it harder to predict how likely the more worst-case scenario C is.
Deputy Governor Sarah Breedon placed most weight on B and did not see C as "likely".
"But if it were to materialise, I would stand ready to react, forcefully if necessary," she added.
Swati Dhingra said all scenarios are in play.
"If the situation were to worsen, this may warrant some tightening, but there is a limit to how much output loss should be acceptable," she added.
Megan Greene said an increase in bank rate "may be necessary" in upcoming meetings.
"We may end up with inflation somewhere between Scenarios B and C, necessitating a tighter stance," she suggested.
Clare Lombardelli placed more weight on the economy evolving as in B, but said C is "plausible", and "would require policy to respond more forcefully to inflationary pressures."
Catherine Mann said: "Should I see continued rising inflation outturns and expectations, I would expect to increase bank rate so as to lean against inflation rising into 2027."
While Deputy Governor Dave Ramsden said he would "consider raising bank rate and accepting a larger output gap as a result," under scenario B.
Alan Taylor placed more weight in the zone between A and the path with standard treatment, where conflict subsides and energy prices moderate to year-end. "This would entail a hold for some time, then a move to a neutral or accommodative stance," he said.
BoE Chief Economist Huw Pill, the sole dissenter in Thursday's vote, argued for a quarter point interest rate increase.
"As someone already concerned about a stalling of the underlying disinflation process even before the latest energy price shock, a prompt but modest hike in bank rate will help mitigate upside risks to price stability stemming from a re-emergence of intrinsic inflation persistence," he said.
Bailey told reporters that the BoE is "not giving the message" that the trajectory for rates is definitely upward.
In the decision statement, the BoE said scenario C would "likely to warrant a forceful tightening in monetary policy".
Bailey told reporters he is "not going to put numbers" on what forceful moves would look like.
Thursday means it is three successive holds for the BoE, after a cutting cycle which saw it reduce rates from 5.25%, where it stood from August 2023 through to August the following.
That BoE around four years ago kicked off a hiking cycle. It lifted rates by 15 basis points in December 2021 and a succession of cuts following, coinciding with Russia's invasion of Ukraine which also prompted an energy price shock. UK consumer price inflation topped 11% in October 2022.
That hiking cycle saw the BoE lift rates by 50 or even 75 basis points at a time in some meetings.
Bailey said the state of affairs is different this time than during the energy price volatility in 2022. Bailey said "monetary policy is more restrictive" now and the labour market is also in a different place. Back in 2022, the jobs market was just emerging from the Covid-19 pandemic.
By Eric Cunha, Alliance News news editor
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