MNI INTERVIEW:Headwinds Mean Slower Tightening- Ex-BOE's Smith

A larger-than-expected hit to real household incomes combined with tighter financial conditions and uncertainty sparked by the conflict in Ukraine mean the Bank of England is likely to tighten monetary policy more slowly this year, James Smith, Research Director at the Resolution Foundation and a former senior BOE economist told MNI.

While upside news since the BOE’s February forecast round includes economic resilience in the face of Omicron and a probable Treasury retreat from fiscal tightening plans, these are outweighed by negatives, Smith said in an interview.

There is “a bigger terms of trade shock, bigger headwinds to the economy, they will have tighter financial conditions from what is happening in the Ukraine, they have got higher uncertainty so I would have thought for the Bank the net of all those things is bigger headwinds and a slower pace of tightening,” he said.

HOUSEHOLD INCOMES

While the Resolution Foundation forecast published on Tuesday for a 4% decline in real incomes in 2022 was not directly comparable with the 2% fall estimated by the Bank in its February Monetary Policy Report, reworking the data on a like-for-like basis still shows the hit to be around twice as large as the Bank assumed, Smith said. The BOE’s estimate uses mean labour income data, while the Foundation’s is based on median household income factoring in housing costs.

The Foundation assumed 8% inflation for the 2022-23 fiscal year starting in April. The resulting 4% hit to real non-pensioner income would halve if inflation were to follow the Bank’s February forecast, though this pre-dated the Ukraine war’s hit to energy and other prices and will inevitably soon be raised.

SLOWER FISCAL TIGHTENING

It now looks very likely that plans by Chancellor of the Exchequer Rishi Sunak for rapid fiscal tightening as Covid support measures are withdrawn will be tempered, at least in the near term, when new fiscal forecasts are unveiled on March 23, Smith said.

“I think we will get some loosening. The Chancellor will have some good news on public finances to help with that in the near-term. Whether that good news is there in the medium term I think is a big question given inflation, given GDP will be weaker than in the OBR (Office for Budget Responsibility) forecast,” he said.

Aside from increasing defence spending, Sunak is under pressure to come up with income support measures for poorer households. Most income-related benefits, including state pensions, are uprated in April by the previous year’s September’s consumer price index, which at present means they will be increased by 3.1% when inflation in April could be around 8%.

“The simplest thing to do is to uprate to the inflation that we … actually see in April. So that is a five-percentage-point larger uprating than they had planned,” Smith said.

While in its meeting next week the BOE will follow convention by factoring the previously-announced tighter fiscal stance into its forecasts, members will still be able to take account of the likely coming loosening of the Treasury's policy setting.

“For them, there will be a little bit of news on that (fiscal) side but … the general, global macro news has been higher inflation, tighter financial conditions, so bigger headwinds basically,” Smith said.