Inflation in the United Kingdom has exceeded the Bank of England’s 2% target. The central bank faces a dilemma as to whether to trim the accommodative measures or not.
Yesterday the United Kingdom’s inflation data for the month of May 2021 was released. Inflation rose above the 2% target set by the Bank of England, reaching 2.1% YoY against a 1.8% forecast. The British pound jumped on the news, but investors preferred to be cautious ahead of the Fed’s decision later in the trading day.
One may argue that the Bank of England will focus on the core inflation data and that the headline is not so relevant. But even the core inflation reached 2% on expectations of only 1.5% – so that the inflation target set by the Bank of England is met.
The big question now – what will the Bank of England do? Now that its mandate has been reached, is it still worth keeping the accommodative measures in place?
The Bank of England and the Federal Reserve
In recent times the Bank of England follows the path set by the Federal Reserve in the United States. Rarely did the Bank of England deviate from the Fed’s course, and usually, it announces its decisions shortly after the Fed.
During the 2008-2009 Great Financial Crisis, the Fed quickly slashed the interest rates to zero. The move was quickly copied by other central banks in the developed world, with the Bank of England being one of the first ones to do so.
During the 2020 pandemic, the pattern repeated. The Fed announced zero interest rates and quantitative easing – so did the Bank of England.
As one can see, the two economies are synchronised in their good and bad times. This is not surprising, considering the fact that the American economy is the largest in the world and that the spillover to developed economies happens quite fast.
Moving forward, the pressure mounts on the Bank of England’s Monetary Policy Committee (MPC). Unlike the Federal Reserve, which has moved to averaging inflation around 2%, the Bank of England does not have such flexibility.
Will it be the first central bank in the developed world to hike the rates in the post-pandemic world?