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Liz Truss on a collision course with the Bank of England on boosting the economy

Britain’s new prime minister is setting up a policy clash with the Bank of England that economists say will lead to a rate hike before Christmas.

Liz Truss’s Generous energy subsidy plan would boost the economy, reduce measured inflation and help households maintain their spending levels, but this is likely to force the central bank to raise interest rates faster to keep inflation in check. control.

Financial markets are betting that the official bank rate will rise from its current level of 1.75% to more than 3% by December in a jump designed to shock households and company.

There are three Monetary Policy Committee Meetings before Christmas, with the first meeting on September 15. Allan Monks, UK economist at JPMorgan, said: “It looks increasingly likely that the BoE will raise interest rates by 0.75. percentage points next week”.

Truss allies said she would announce a plan to tackle soaring energy costs on Thursday based on freezing energy bills at £2,500 a year, larger than economists expected economic. The BoE did not offer any fresh support in its August forecast.

The energy bill freeze would prevent inflation from rising much higher than the 10.1 percent hit in July, but the BoE thinks the economy needs to go into a recession to sustain inflation. .

Monks added that a large fiscal stimulus would curb the risk of a recession, but that “will likely make the economy and the labor market more resilient than the BoE expected in September.” August, and places a greater burden on banks to reduce inflation by charging higher interest rates.”

He said monetary and fiscal policy is likely to “clash”.

In a tough speech on Monday, Catherine Mann, one of the bank’s MPC external members, said rate hikes needed to be “swift and forceful” to show the BoE was serious about achieving its inflation target. It is better than relying solely on the weakness of the economy to bring down inflation, she said.

Writing in the Financial Times this weekKwasi Kwarteng, who was appointed prime minister on Tuesday, said that “coordination between monetary policy and fiscal policy is very important”.

But economists say this will be nearly impossible to achieve if the government is looking to increase spending while the BoE is trying to reduce demand.

James Searle, European interest rate strategist at Citi, warned that “fiscal and monetary policy in the UK is now set to pull in different directions”.

Column chart of December 2022 interest rate expectations (%) shows financial market expectations by the end of 2022 BoE interest rates have increased monthly over the past year

Searle added that the development is “concerning” as Treasury policy would conflict with central bank policy, and “it also reveals a fundamental irrationality in the analytical framework used by central banks and financial authorities”.

With the BoE delivering its final word, Searle predicts that “the MPC will respond with increasing levels of aggression to further fiscal easing.”

Jonathan Portes, professor of economics at King’s College London, believes this conflict is inevitable. “Trussonomics means borrowing more,” he said, warning that while increasing government debt is not an issue for the BoE when interest rates are kept near zero, it is not currently. is applied.

“UK interest rates are high and trending up. Of course, inflation is at around 10%,” Portes said.

Line chart of CPI inflation with forecast (YoY,%) showing that freezing energy prices will reduce measured inflation rate when it is active

Truss, meanwhile, has become less aggressive towards the BoE as she moves closer to power.

In July, she wants to review BoE’s mission and calling on the ministers to give the bank “a very clear direction on monetary policy”. But this week, she pledged to support bank independence, saying “the Bank of England’s mission is to bring down inflation”.

Her comments will give Andrew Bailey, the BoE governor and other officials at the bank some reassurance that Truss and her chancellor will not oppose higher rates. The governor and his colleagues will appear at the House Treasury selection committee on Wednesday to outline their latest thinking.

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