The Bank of England (BoE) should not be concerned by inflation whatsoever as the economy is not showing signs of overheating, according to KPMG UK’s chief economist, Yael Selfin.
Selfin says the BoE’s monthly figures, released last week, forecast a much stronger economic recovery from the pandemic but inflation will remain under control and not require a rise interest rates to counter it in the near-term.
“ [The BoE] don’t want to be too premature and stop the party too early. We still need to gain more ground,” she says. “I think their judgement will be that there’s no major inflationary pressures that they should worry about.”
“So, potentially we may not even see rates going up for the next two years. It will be a few more years before we see rates starting to normalise”
The BoE said it expects the UK economy to grow by 7.25 percent this year, up from its previous forecast of 5 percent it made three months prior. The Monetary Policy Committee (MPC) also voted unanimously to keep interest rates at the historic low of 0.1 percent.
However, outgoing chief economist at the BoE and MPC member, Andrew Haldane, voted against continuing with the Bank’s additional programme of UK government bond purchases totalling £895bn by the end of the year, instead preferring to limit it to £825bn. In fact, minutes from the meeting show that Haldane was concerned the improved economic outlook meant some tightening by the BoE was warranted, suggesting he was concerned about inflation getting too high this year.
However, despite inflation concerns causing market jitters this week, with the FTSE 100 falling more than 2 percent in early morning trading on Tuesday, Selfin remains optimistic.
“While we are very upbeat about the prospects for the UK economy in the short term, and expect inflation to rise above the BoE’s target of 2 percent…we see economic growth moderate later this year and inflation returning to target without the need for the BoE to raise rates at this point,” she says.
Selfin argues that the BoE can keep rates low because the inflationary pressure are largely external.
“The main inflationary pressures that we’ve seen so far are related to oil which is not really showing that we are overheating in terms of demand.
“Wage inflation, a lot of it is due to structural mix – so the jobs that were lost were in lower wages, whereas the jobs that were kept were higher wage jobs, it’s not showing actual wage increases,” she adds.
Brexit-related issues are also causing “friction” in the economy due to higher costs when crossing the border into the EU for some goods and services. These issues give the impression of inflation but do not actually signal an overheating economy, Selfin says.
“The other thing that you need to bear in mind is that we still have risks. We still have risks around the pandemic, we could see a new variant… and there could be other things.”
Government support strategy must shift
As the vaccine rollout continues and restrictions ease, government support schemes will also come to an end. The furlough scheme is due to end in September 2021, while VAT deferral payments are due by June 30 2021.
Last summer, in an effort to support the UK economy, Chancellor Rishi Sunak introduced the “Eat Out to Help Out” scheme to incentivise consumers into restaurants and bars.
However, Selfin says that while this was an extremely popular policy, it is now clear that consumers are not in need of extra support.
“A lot of them are sitting on quite a lot of savings,” Selfin says. “The government needs to step in more strategically – looking at the future, looking at productivity, looking at the growth agenda, looking at the levelling up agenda. It’s no longer about the protection of the economy.”