Sunday, December 19, 2021
Awful timing from the Bank - let's hope it's not a futile gesture
Posted by David Smith at 09:00 AM
Category: David Smith's other articles

My regular column is available to subscribers on This is an excerpt. Not to be reproduced without permission.

It never rains but it pours. Just as we are trying to get to grips with the Omicron variant of Covid, along comes inflation. We knew we were experiencing an inflation shock, but the latest figures, showing consume pic inflation at 5.1 pe cent, and retail price inflation two percentage points higher at 7.1 per cent, were a shocker. “Not now, inflation,” was a reasonable response when there was already so much bad news around.

I have hesitated to use the word “stagflation” to describe the current situation, not least because it Is an insult to the great stagflations of the past, some of which had inflation at more than 20 per cent alongside recession.

But this upsurge in inflation has occurred at a time when growth was stagnating even before the Omicron variant came onto the scene and has been pushed into reverse by the economic effects of that variant. If the cap fits, and we should at least acknowledge that we have a mini stagflation on our hands, notwithstanding strong job market and retail sales data.

It was into this environment that the Bank of England raised interest rates on Thursday, from a record low 0.1 per cent to 0.25 per cent. Until the release of the inflation data, most people would have regarded even this modest hike as a non-starter because of Omicron. But to be fair to the Bank, it stuck to its guidance in November, which was that if the labour market held up well after the end of the furlough scheme on September 30, it would hike rates. The inflation figures, embarrassing for a central bank tasked with keeping inflation at 2 per cent, tilted the balance.

Being fair to the Bank only goes so far, however. Though some of us have urged the Bank to tighten policy for many months, initially by reining back its quantitative easing (QE) programme, and more recently by raising rates, this was not a great time to start. The country is reeling under the Omicron wave and the latest surveys, notably the purchasing managers’ survey, shows a sharp weakening of the service sector this month, for understandable reasons. Many businesses ill see this as a kick in the teeth, on top of the other pressures they face. As well as “not now, inflation,” they would say “not now, interest rates”.

When the hike was announced, which according to the Bank will not prevent inflation averaging 5 per cent over the winter and hitting 6 per cent in the spring, it brought to mind a famous comedy sketch.

This was the Beyond the Fringe sketch – younger readers ask your parents or look it up – in which Peter Cook, as a senior RAF officer, tells Jonathan Miller, his junior, to “pop over to Bremen” on a suicide mission, because the war wasn’t going well “and we need a futile gesture.

The Bank would say that while the war on inflation has not been going well, its gesture was not futile. By raising rates at a difficult time, it may have won back a little hawkish credibility. It is, after all, the first major central bank to do so. Last week’s rise, moreover, should be seen as the first in a sequence, which could see several more increases. The Bank was behind the curve, and his was a bit of a catch-up.

Covid is the big uncertainty. The Bank was briefed by Professor Chris Whitty, the government’s chief medical adviser. Economists are not epidemiologists and some who have tried to model the course of the virus have fallen spectacularly flat on their faces. Mind you, epidemiologists have not always covered themselves with glory, far from it. Faced with the uncertainty of the moment, economists are resorting to a familiar tool, and one which is used widely in business, scenario planning.

Continuum Economics, an independent macroeconomics and financial markets research firm, has devised four scenarios. They apply to the world economy but can be easily adapted for the UK.

Under the first, Omicron has higher transmissions but is similar in severity to Delta. Many countries impose further restrictions and lockdowns, and people shift their consumption patterns back to goods and away from services such as hospitality. Growth is adversely affects in the first half of next year, but then picks up. The inflation impact is mixed; stronger in goods but weaker in services. The firm puts a 40 per cent probability on this outcome.

At the other end of the scale, also with a 40 per cent probability, is that Omicron has higher transmission but is milder and vaccine effectiveness if not seriously compromised. There is a modest effect on growth in the next few months, but there is also a bigger inflation risk. Growth does not slow enough to bear down on inflation and there is a greater danger of second round effects, in which, for example, higher inflation feeds through into wage settlements.

There are two other scenarios. One, with a 15 per cent probability, is when fast-spreading Omicron seriously reduces vaccine effectiveness. Growth takes a bigger hit, and this takes some of the steam out of inflation.

The final scenario, with just a 5 per cent probability, is if Omicron turns out to be a damp squib, less transmissible and less severe than Delta. The growth and inflation effects are marginal. We may already have enough evidence to reject the idea that Omicron is less transmissible.

People and businesses will have their own ideas about the likely path of the virus in coming weeks and whether Boris Johnson’s government would be able to introduce new restrictions even if it wanted to. It could be too that the changes in behaviour that we have seen in response to warnings about Omicron will fade and that people, taking precautions, decide it is a risk we have to live with. Omicron delays the return to normality but does not take us back to square one.

There are, nevertheless, some striking things about all this. Never before has a single issue, Covid, dominated the outlook as it does now. The uncertainty seems greater than this time last year.

On most projections, however, the growth effects of continuing Covid appear to be quite modest. This is because, as we saw with the three UK lockdowns (so far), their effect diminished, from massive in the spring of 2020 to modest. The Bank picked up on this in the minutes of its latest meeting, noting: “The experience since March 2020 suggested that successive waves of Covid appeared to have had less impact on GDP, although there was uncertainty around the extent to which that would prove to be the case on this occasion.”

If the growth effects are modest, that adds to the fear that inflation will be a problem for longer and raises the question of whether the Bank’s actions will impact on some of the structural factors creating it, including supply chain problems and labour shortages. I suggest a couple of weeks ago that the Bank might be a bystander in the inflation process. It has elbowed its way in. Mainly, however, if inflation falls it will be due to factors outside its control.