Central banks fall far behind the curve on inflation

The Bank of England may have raised interest rates and the US Federal Reserve is tightening policy too, but with inflation soaring, is it too little too late?

“Surprise, surprise!”, says Ipek Ozkardeskaya of Swissquote. Last month the Bank of England failed to raise interest rates despite market bets that it would. This month it has pulled the reverse trick, becoming the first big central bank to raise the cost of borrowing. The 0.15 percentage point rise to 0.25% came despite market bets that Omicron-related uncertainty would cause the Bank to keep policy steady. With inflation at an annual rate of 5.1% and predicted to hit 6% next April, the Bank decided it didn’t have the luxury of waiting for more clarity about Omicron. 

Fighting for credibility 

The interest rate rise is so “marginal” that it is “frankly… unlikely to make much of a difference”, says Jeremy Warner in The Daily Telegraph. All the same, it is an important signal of intent. After a year spent making increasingly unconvincing excuses for soaring inflation, Threadneedle Street needed to head off speculation that its real objective is to keep government borrowing costs low. The Bank has now shown that “it won’t back excessive spending forever”.

Even those of us who have long supported tighter policy must admit that “this was not a great time” to start raising rates, says David Smith in The Sunday Times. UK “growth was stagnating even before Omicron” and inflation has surged, suggesting a “touch of… stagflation”. The service sector is having a nightmare before Christmas. “By raising rates at a difficult time”, the Bank has at least “won back” some of its lost credibility as a central bank that takes inflation seriously.

“Omicron or no Omicron”, the Bank had no choice but to raise interest rates, says Liam Halligan in The Daily Telegraph. Inflation is more than two times the 2% target. November’s rate-rise-that-wasn’t debacle had raised serious questions about Threadneedle Street’s willingness to both raise the Treasury’s borrowing costs and to upset market traders, who love easy money. Credibility is “a must-have for any effective central bank”: if businesses and consumers come to believe that authorities will never act against inflation then it will become “a self-fulfilling prophecy”. 

Fed turns hawkish 

The US Federal Reserve is also in tightening mode. It says it will reduce its monthly asset purchases twice as fast as previously planned. That leaves the Fed on course to wind up its quantitative-easing programme (whereby it buys bonds with printed money) and start raising US interest rates next spring. The Fed’s latest projections show it plans to raise interest rates up to three times during 2022. 

For all the fanfare about its newfound hawkishness, “the Fed has effectively committed not to raise rates above 1% in 2022”, says Philip Pilkington on Unherd. Yet annual US inflation is 6.8%. “I do not envy the job of central bankers these days.” Policymakers are stuck between the rock of raising rates sharply, which will cause a market crash, and the hard place of doing nothing, which will let inflation rip. The Fed’s solution? “Magically assuming in their projections that inflation will disappear” by itself. 

Recommended

How to claim compensation for travel delays
Personal finance

How to claim compensation for travel delays

It promises to be a summer of chaos at airports, with thousands of flights cancelled and huge queues, while strikes on the railways haven't helped eit…
5 Jul 2022
Is it OK to buy Scottish Mortgage investment trust again?
Investment trusts

Is it OK to buy Scottish Mortgage investment trust again?

Scottish Mortgage investment was hit hard by the tech-stock crash, and it is still being buffeted by headwinds. Should new investors wait for those to…
5 Jul 2022
Britain’s ten most-hated shares – w/e 1 July
Stocks and shares

Britain’s ten most-hated shares – w/e 1 July

Rupert Hargreaves looks at Britain's ten most-hated shares, and what short-sellers are looking at now.
4 Jul 2022
Britain’s most-bought shares w/e 1 July
Stocks and shares

Britain’s most-bought shares w/e 1 July

A look at Britain’s most-bought shares in the week ending 1 July, providing an insight into how investors are thinking and where opportunities may lie…
4 Jul 2022

Most Popular

Ray Dalio’s shrewd $10bn bet on the collapse of European stocks
European stockmarkets

Ray Dalio’s shrewd $10bn bet on the collapse of European stocks

Ray Dalio’s Bridgewater hedge fund is putting its money on a collapse in European stocks. It’s likely to pay off, says Matthew Lynn.
3 Jul 2022
UK house prices are definitely cooling off – but are they heading for a fall?
House prices

UK house prices are definitely cooling off – but are they heading for a fall?

UK house prices hit a fresh high in June, but as interest rates start to rise, the market is cooling John Stepek assesses just how much of an effect h…
30 Jun 2022
Persimmon yields 12.3%, but can you trust the company to deliver?
Share tips

Persimmon yields 12.3%, but can you trust the company to deliver?

With a dividend yield of 12.3%, Persimmon looks like a highly attractive prospect for income investors. But that sort of yield can also indicate compa…
1 Jul 2022