UK inflation soars to three-decade high intensifying monetary policy dilemma31 January 2022
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Bank of England toughens hawkish pivot to ease inflation pressures
The Bank of England (BoE) ramped up efforts to control spiralling inflation with the first successive increase in interest rates in 18 years and signalled the start of quantitative tapering (QT).
The Bank’s Monetary Policy Committee (MPC) voted for 0.25% increase in the base rate to 0.5% by a majority of five to four. MPC members in the minority preferred an even higher increase by 0.5 percentage points, to 0.75%. Markets now expect the base rate to reach 1.25% by year-end. The voting distribution underscores the central bank’s hawkish tilt towards taming inflation, which is expected to climb higher in the coming months.
The annual consumer price index (CPI) inflation rate rose to 5.4% in December. This is expected to reach 6% in February and March and peak at around 7.25% in April. UK inflation has surged due to sharply rising wholesale energy prices underpinned by strong demand and rising geopolitical tensions, which will keep costs elevated for at least the next six months. The UK is a net energy importer. Tight labour markets continue, despite the closure of the furlough scheme, placing upward pressure on wages. Unemployment fell to 4.1% in the three months to November and is expected to fall further in the months ahead. In addition, the impact of supply bottlenecks continues to weigh on tradable goods prices, although some easing is expected towards year-end. Food price inflation is also expected to push higher, driven by higher input costs.
The MPC voted unanimously to reduce UK government and corporate bonds holdings by ending reinvestment of matured holdings and in corporate bond sales by the end of next year. The accelerated rundown of the BoE’s balance sheet unwinds years of central bank-provided liquidity to support the UK economy, which accelerated after the onset of the pandemic two years ago. Faster balance sheet reduction may have the effect of tightening monetary conditions sufficiently to ease inflation, reducing the need to increase the base rate beyond the implied market path of 1.5% by mid-2023.
Impact for UK companies
Tightened financial conditions will impact companies differently – from increased borrowing costs on floating-rate loans to higher input costs (e.g. suppliers costs, wages, energy, etc.) and commercial rent increases for companies with inflation-indexed leases.
Around three-quarters of corporate bank debt is charged on a floating interest rate, according to the BoE. For such borrowers, the 50 basis points increase in the base rate since December will be felt quickly. However, loans under the government’s Bounce Back Loan Scheme (BBLS) were priced at a fixed rate of 2.5% and will be unaffected. At the same time, demand growth may have softened for firms due to the Omicron wave, leading to elevated stock levels, while the Treasury forewarned of future corporation tax rises in last year’s Budget.
Tightened financial conditions amid rising inflation and decelerating growth will weigh on the outlook for UK company insolvencies.
UK voluntary insolvencies in Q4 rose to the highest level on record
The number of distressed companies in England and Wales that entered voluntary insolvency in the final quarter of last year rose to the highest levels in more than 70 years, according to government data.
In the fourth quarter, data from the Insolvency Service showed there were 4,175 creditors’ voluntary liquidations (CVL), where directors voluntarily elect to transfer distressed companies into liquidation without a formal court order. The fourth quarter spike compares with 3,634 in the prior period and represents a new record high since records began in 1960.
Total annual company insolvencies were 14,048 in 2021 (2020: 12,634), 90% were CVLs, marking the highest annual number since 2009. Several factors explain the surge in insolvencies in the final months of last year, including the expiry of Covid-era government support (e.g. the furlough and government-backed loan schemes) and the suspension of wrongful trading liability. At the same time banks have stepped up requests for repayment on Covid-era loans extended during the pandemic, while periodic mobility restrictions stifled trading and clouded cash flow visibility.
These headwinds all affected companies across industries differently. Companies in the construction (2,579: 19.6%), the wholesale and retail trade sector (1,722: 12.3%), and accommodation and food services (1,673: 11.9%) suffered the most insolvencies, according to the data. Small companies are also more sensitive to pandemic disruption.
Governments cannot indefinitely support weakened businesses. As 2022 rolls on, companies will have to readapt to self-sustainability in order to survive.