Home ›› 14 Nov 2021 ›› Editorial
Bank of England [BoE] is the central bank of the United Kingdom that was established in 1694 as a joint-stock company; and with nationalization in two phases the entity ultimately emerged as the BOE in 1946. It has a captivating nickname; ‘The Old Lady of Threadneedle Street’ or simply ‘The Old lady’. It is the eighth oldest Central Bank in the world. Any decision on monetary policy by BOE is governed by the Monetary Policy Committee [MPC] which consists of nine members; the Governor, the three Deputy Governors for Monetary Policy, [Financial Stability, Markets, and Banking], Chief Economist, and four independent external members appointed directly by the Chancellor. External members work as a balancing factor since they do not represent individual groups or regions.
The context of BoE in interest rate management needs to be evaluated on several determinants; the most important is on the context of the Brexit issue. The United Kingdom’s exit from the EU paved the way for more meaningful ventures in the pursuance of monetary policy. The United Kingdom maintained GBP as the legal tender with an independent monetary policy though, within the framework of membership, the monetary authority exercised reservations on many counts in the formulation of the monetary policy. Future trajectories of economic growth after Brexit on trade issues and the new phases of economic integration are important in the long run in navigating the monetary policy through various instruments. Interest rate is an important policy variable in monetary policy and fixing interest rates at a higher or lower level could have an effect on both currency value, fiscal deficit, and growth. This depends on the various determinants such as the health of the economy, expected inflation, and interest rate applicable to other treasury bonds or savings instruments.
The two contexts in this paper related to higher inflationary expectation after the scourge of pandemic as we now observe in many developed countries and another was the deflationary syndrome before COVID-19. The BOE base rate was 0.50 from 2012 to July 2015, the rate dropped to 0.25 per cent in 2016 but then jumped to 0.5 percent in October 2017, the rate stood at 0.75 percent in August 2019. The rate sharply dropped in late March 2020 to 0.1 percent, the lowest in history. Pitted against this historical interest rate, the inflation rate dropped to 0.1 percent in 2015 after an average inflation rate of 2 percent during 2012-2014. The inflation rate jumped to an average of 2.6 percent during 2017-18 after an average rate of 0.4 percent during the previous two years. The inflation rate was 1.8 percent in 2019 but dropped to 0.9 percent in 2020. Projections on inflationary expectations indicate upward incremental change from 1921 to 1926 with flat level inflation at 2.00 percent from 2024-2026. Base rate or interest rate or the Bank Rate is the rate charged by the central bank when a commercial bank borrows to meet an emergent liquidity crisis. As a norm, the rate is lower than the deposit rate. “Inflation is set to rise to 5 per cent - more than double the BoE's 2 per cent target - despite a slowdown in the economy's recovery from last year's slump, and BoE Governor Andrew Bailey emphasized on the need to act to contain infInflation expectations.” Interest rate and inflation or inflationary expectation move in tandem: higher interest rates assuage the inflationary pain but in the event of moderate inflationary expectation keeping the interest rate at a historically low level may not be a genuine policy directive as BOE now embarks. “ The analysts predicted the MPC would vote 6-3 to raise Bank Rate to 0.25 per cent from its record low of 0.1 per cent, after Bailey's comments prompted a surge in bets in financial markets on a hike.“
The data manifest a moderate correlation of inflation and interest rate in many instances such as the correspondence between inflation and interest rate in 2020. However, the projection from 2021 to 2026 may not be a match between Inflation and interest rate as the interest rate at 0.1 percent against the inflation rate of 1.51 percent in 2021 and 1.82 percent in 2022 unless the BOE increases the rate to match the higher inflation rate. A few economists however apprehend that the economy requires more time for convalescence and interest rate needs to be lowered for stimulating growth. The current inflation rate at 0.9 percent with the inflation of 2016 of 0.7 almost tallies with the interest rate of 0.1 percent prevailing in 2019.
The UK composite purchasing managers’ index [PMI] that records the vitality of economic activity fell to 54.1 in September 2021 from August's 54.8 though higher above the 50- threshold, signaling a softer improvement in business conditions from the previous month but the weakest reading since February 2021. The manufacturing sectors where production was inhibited by severe supply-chain disruptions and stronger demand compounded by a deterioration in the services sector, especially the scarcity of the truck driver. "The September 2021 PMI data will add to worries that the UK economy is heading towards a bout of ‘stagflation’, with growth continuing to trend lower while prices surge ever higher. […] Shortages are driving up prices at unprecedented rates as firms pass on higher supplier charges and increases in staff pay. Brexit was often cited as having exacerbated global pandemic-related supply and labor market constraints, as well as often being blamed on lost export sales.”
The rate cut is a delicate issue for BOE with GBP constituting over 5 percent weight in international transactions; the currency is ranked at the third position after USD and Euro. Low-interest rates cause currency value to fall. Indeed on the expectation that a lower interest rate was on the offing; the GBP slipped back to $ 1.30 as it fell 0.2 percent to $ 1.2990 with a consequent fall in the UK’s 10-year gilt yield at a 10-week low of .065 percent in 2019. While the outlook is uncertain, the BoE needs to take inflation seriously but not rush to raise rates to prove its credibility.
The writer is the Treasurer and a Professor at the School of Business and Economics, United International University. He may be contacted at obaidur@eco.uiu.ac.bd.
