Bank of England faces a stiff test

LONDON: Whatever new year boost the euro zone economy got from ebbing natural gas prices, the UK saw none of it — showing just how peculiarly British the downturn there has become and heaping pressure on the Bank of England.

January business surveys last week showed euro zone economic activity expanding again for the first time since June — helped by an unusually warm winter that has led to more than a halving of sky-high natural gas prices over the past six weeks.

Although Britain saw the same easing of energy prices, UK industry — in stark contrast — continued to contract. In fact it shrank at its fastest pace in two years, with everything from inflation and rising interest rates to worker shortages, labour strikes and mounting Brexit damage being blamed. Sterling suffered its biggest one-day drop against the euro in a month.

A Confederation of British Industry poll doubled down on the downbeat message and showed order books weakening further this month despite an easing of cost pressures.

Whatever the precise reason for the persistent gloom, it leaves the central bank in a pickle as it tries to rein in still double-digit inflation and record private sector pay growth without sinking the housing-sensitive economy even deeper into the mire.

The BoE meets again this week and there are growing calls for it to start to winding down its year-long campaign of interest rate hikes that have already brought its main policy rate to 3.5% from just 0.1% in December 2021.

Whatever the merit of those calls, most forecasters suspect the BoE will press on for now. More than two thirds of the 42 economists polled by Reuters expect another rise of 50 basis points to 4% this week.

Financial market pricing is even more aggressive. Despite economic funk, the implied peak BoE rate derived from money and swaps markets shows almost another full percentage point of hikes to 4.5% before the Bank calls it quits later this summer. What state the economy will be in by then is anyone’s guess. Hedge fund manager Stephen Jen at Eurizon SLJ thinks the post-Brexit orientation — or lack thereof — of British economic policy is still hard to figure.

“I’m still puzzled by why (Prime Minister Rishi) Sunak seems busier signing more defence pacts than trade pacts,” he said. “The UK’s cyclical and structural failings by the government post-Brexit are evident.”