Bank of England’s Lombardelli warns that rates will probably rise unless energy shock fades
Newsflash: A Bank of England deputy governor is warning that interest rates will be raised, if necessary, to combat the risk of persistent inflationary pressures from higher oil prices.
Clare Lombardelli is telling the Sixth Biennial Conference on Macroeconomic Policy in Warsaw that the energy shock due to the conflict in the Middle East is likely to keep pushing UK inflation higher in the coming months.
Lombardelli points out that businesses have proved more resilient to higher energy costs than the Bank expected. But…. the longer energy prices remain high and volatile, the greater the risk for pass-through more widely into domestic wages and prices. she says.
Lombardelli is one of six Bank policymakers who voted to leave interest rates on hold last week, outvoting their three colleagues who voted for a rise in interest rates.
She also warns that other global costs could add to inflation, saying:
Strong demand for AI components is already pushing up global export prices and weather-related shocks add upside risks. On the other hand, trade diversion is reducing inflation.
The key question is whether “second-round effects” – where high inflation pushes up wages, fuelling inflation – are developing.
Lombardelli says there is “material uncertainty” about the size and duration of the energy shock.
But unless there is also evidence that the economy is weakening, interest rates will probably have to rise, she says:
The longer higher energy prices persist, the greater the risk that indirect effects build and that inflation expectations, wage bargaining and price-setting behaviour begin to adjust in response.
On that basis, policy is increasingly likely to need to tighten if elevated energy prices persist, absent clear evidence of disinflation or weaker activity. But this is by no means suggesting that monetary policy should respond mechanically to movements in energy prices. The key issue is not the spot price of energy itself but the interaction of the underlying economy, higher energy prices, and the nature of their transmission. That, ultimately, is what will determine whether Bank Rate needs to rise.
Key events
FTSE 100 ends the day lower
The UK’s blue-chip stock index has ended the day in the red.
The FTSE 100 index fell by 25 points or 0.24% to close at 10,679 points.
“The continued ascent in US borrowing costs is causing jitters on the markets,” says Dan Coatsworth, head of markets at AJ Bell, adding:
“The US 30-year Treasury yield hit 5.447%, the highest level since 2004, with investors focused on inflationary pressures as oil remains stubbornly above $100 a barrel. The black stuff jumped 2.6% to nearly $106 a barrel.
“Bond investors are grumpy at the prospect of interest rates going higher, so they’re voting with their feet and selling existing bonds. As prices fall, yields rise, which reflects the higher return investors now demand.
Bond yields climbing again as oil rises
The oil price has jumped again, pushing bond yields higher, following reports of more military clashes between Saudi Arabia and Houthi forces.
Six ballistic missiles targeting Saudi Arabia’s port of Yanbu on the Red Sea and the southwestern city of Taif have been intercepted, a Saudi military spokesperson said Thursday, blaming Iran-backed Houthi rebels in neighboring Yemen, Associated Press reports.
And Reuters reports that Yemen’s Houthis say they have attacked Saudi military sites in Jazan, which is around 1,000km to the south.
Brent crude is now up almost 4% at $107.13 a barrel, creating new inflationary concerns that are pushing up goverment borrowing costs again.
The UK’s 10-year bond yields, which had subsided earlier, are back up to 5.385%, a gain of seven basis points (0.07 of a percentage point).
Thirty-year UK bond yields are also up around 7bps to 5.88%.
BoE’s Breeden: Rates decision is not like 2022
The Bank of England’s Sarah Breeden has also played down the likely need for a dramatic increase in interest rates should the war in Iran continue through the autumn and into the winter months.
Speaking at the Macro Policy Forum at Imperial College in London, she said:
“We are not talking about immense differences around the MPC table. We are talking about 0.25 basis points up or down, which is small beer. It is not like 2022 when we had a mountain to climb.”
Breeden said she welcomed the review of the Bank’s remit by MPs on the Treasury committee (see earlier post).
“It is always healthy to check the remit,” she said, adding:
“The world in which we are doing monetary policy now feels very different to the one 20 years ago. In a world of shocks, of structural shifts, when you are using a different set of tools, it is healthy to step back and ask whether we are set up in the right way and have we got the legitimacy, as a bunch of unelected officials, to take the decisions we do. I think the answer is we do, but it can only be a good thing that we look at it because on the other side of the pond we have seen some challenges to central bank independence.”
Isabel Schnabel, a senior European Central Bank official, is leaving the eurozone central bank early to take on a top job at the IMF.
Schnabel has been lined up to become the IMF’s next financial counsellor and director of the monetary and capital markets department.
IMF chief Kristalina Georgieva says:
“Isabel is a well-respected leader and communicator,.
She is well known for her collaborative leadership style, commitment to developing talent, and ability to build consensus around complex policy issues. At a time of profound transformation, her intellectual leadership, policy experience, and commitment to international cooperation will further strengthen the Fund’s work to promote global monetary and financial stability. We look forward to welcoming her to the Fund.”
Schnabel is a member of the ECB’s executive board, so this means a deeper shake-up at the bank, where president Christine Lagarde is expected to leave before her term as president expires in October 2027.
Another central bank decision today: Ghana’s central bank has maintained its main interest rate at 14.00%.
Analysts at Investec have predicted that the Bank of England’s patience with high energy costs is “wearing thin”.
They now believe the BoE will hike interest rates in November, and again three months later, telling clients:
Unless there is material progress in negotiations that see substantial energy flows resume transit through the Strait of Hormuz, we imagine that tolerance for the majority of committee members will soon run thin, triggering a 25bp rate hike, likely in November.
We think that will be followed by a further lift in rates in February, with committee members preferring to wait to increase interest rates again until they have the backing of a new set of Monetary Policy Report economic forecasts. Similar to the Fed and the ECB, we imagine this extra policy restriction will be removed in the second half of next year once conditions normalise, resulting in an end-2027 Bank rate of 3.75%.
A second Bank of England deputy governor has suggested that UK interest rates could be pushed higher to combat higher energy prices.
Bank of England deputy governor Sarah Breeden told the UK Macro Policy Forum organised by the National Institute of Economic and Social Research:
“The larger and longer the shock, the more likely it is that we’ll see the material second-round effects that policy needs to respond (to).
“I wasn’t there in September (in terms of being ready to vote for a rate hike), but I was mindful that the balance of risks had shifted, and as risks crystallise it’s increasingly appropriate for Bank Rate to respond.”
Markets in ‘recovery mode’ as Wall Street opens lower
The US stock market has opened in the red, as investors fret about the recent slide in bond prices.
The Dow Jones industrial average, which tracks 30 large US companies, has dipped by almost 0.54% at the open, with the broader S&P 500 index down 0.4%.
Although bond yields have dipped back from their earlier highs, there’s still a lot of uncertainty out there.
Kathleen Brooks, research director at XTB, says:
Markets are in recovery mode as we move into the US session on Thursday. Bond yields are bouncing around like a see-saw, up one minute and down the next. Brent crude spiked to as high as $106 per barrel earlier, before dropping 3%, and futures prices are now back below $100 per barrel.
There is no clear direction for markets. Are we in a bond crisis or not? Is the Iran war getting worse or is the situation improving? Are enough oil supplies getting through the Strait of Hormuz, and will Ukraine continue to target Russian refinery infrastructure?
US jobless claims drop
Just in: US companies continued to hold onto staff last week, keeping layoffs low.
New data from the US Department of Labour shows there were 197,000 new ‘initial claims’ for unemployment support last week, a drop of 1,000, and a low figure in historic terms.
Back in the markets, the pound has dipped to its lowest level against the US dollar in almost three months.
Sterling has slipped by 0.1% to $1.322, its lowest level since 1 July, as traders anticipate the US Federal Reserve is more likely to raise interest rates in October.
