A difficult task has just become slightly easier for the Bank of England, following Chancellor of the Exchequer Rishi Sunak's 15 billion-pound ($19 billion) relief package announced Thursday. The measures, including energy bill subsidies for every UK household plus one-off grants to pensioners and welfare recipients, mark a spectacular U-turn by the government as the cost-of living crisis worsens. But the arrival of the fiscal cavalry eases the potential impact on growth, freeing the central bank to focus on curbing a surge in consumer prices that threatens to savage the financial health of the most needy.
At its most recent policy meeting, BOE Governor Andrew Bailey raised the prospect of the economy stalling, setting the scene for a dangerous economic backdrop given that inflation is already at a 40-year high of 9% and is set to reach double figures in the coming months. Sunak's rediscovery of the magic money tree, missing in action since the pandemic relief program ended, belatedly undoes some of the economic damage inflicted by the tax increases he introduced earlier this year on companies and workers. If the government is alive to the risk of recession, the central bank can get on with the job of tackling price increases.
In a newspaper interview published earlier this week, BOE Chief Economist Huw Pill made clear that there is some way to go in this current rate-hiking cycle, which has seen policy tightened at four consecutive central bank meetings, although he was careful to stress acting too quickly also poses risks. While the prospect of 50 basis-point increases seems unlikely, the strength of the UK labor market, with the unemployment rate at a 40-year low of 3.7%, is likely to persuade policy makers to raise the official bank rate to 1.25% at its next meeting on June 16. Dan Hanson at Bloomberg Economics expects the rate to climb to 2% by November, at which point he expects a halt; the futures market sees even more action into next year.
I'm less confident that the BOE will hike another four times this year, unless consumer confidence and spending rebound after hitting a brick wall this spring. Moreover, the S&P Global composite purchasing managers survey collapsed to 51.8 this month, down from 58.2 in April and barely above the 50 level that separates expansion from contraction. Economists had predicted a reading of 56.5. If evidence of an economic slowdown continues to build, policy makers could well pause mid-summer to assess the impact of their repeated rate increases.
Sunak is financing his fiscal largesse with what he called a "temporary, targeted energy profits levy" — aka a windfall tax — on oil and gas companies. It's designed to raise 5 billion pounds, although it is far from clear what the final tax take will be as there are offsetting investment incentives for the firms involved. Thursday's helicopter money-drop is equivalent to 0.6% of gross domestic product, and pretty much all of it is (by design) likely to be spent on energy bills rather than saved by consumers. This means other spending that might have been put off will go ahead, adding a mild contribution to the current inflation impulse.
Still, political needs must. While this fiscal splurge brings short-term relief for those most in need, it is far from all that will be needed to defend society's most vulnerable members from the coming financial storm, so more government intervention is likely either later in the summer or at the November budget. By acknowledging its fiscal responsibilities, the government has in effect freed the central bank to act independently in setting monetary policy. Given the current febrile economic environment, that's a welcome development.
Marcus Ashworth is a Bloomberg Opinion columnist covering European markets. Previously, he was chief markets strategist for Haitong Securities in London.
Disclaimer: This article first appeared on Bloomberg, and is published by special syndication arrangement.