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RPT-COLUMN-BoE being goaded into 'scorched earth' policy :Mike Dolan

(Repeats earlier column with no changes to text)

By Mike Dolan

LONDON, Aug 5 (Reuters) - Torn between inflation and recession, the Bank of England is being pushed hard by a UK government-in-flux into a scorched earth monetary policy now and possibly an equally dramatic and unnerving U-turn next year.

Foreign Minister Liz Truss, overwhelming favourite to replace Boris Johnson as Prime Minister next month, plans looser fiscal policy via largely unfunded tax cuts in an "emergency budget" - a plan many fear could force the central bank into an overburdened solo effort to rein in raging prices as the economy heads into a long recession.

As if to reinforce that point, Truss' campaign team openly complains the Bank was too slow in tackling inflation last year and insists on a review the central bank's 25-year-old operational independence by way of censure.

The irony of this threat to BoE independence is that it goads the bank to tighten even more aggressively now to sate public anger over higher bills and allow room for quick tax cuts - contrasting with a perennial fear that government interference in central banking typically tries to engineer cheaper credit.

But many feel that political pressure to tighten harder now could quickly flip-flop next year too - creating the sort of macro policy volatility investors may balk at.

In a report entitled "Nightmare on Threadneedle Street", Rabobank's Stefan Koopman reckons fiscal easing implied by "Trussonomics" will reinforce expectations for another 100 basis points of BoE rate rises by year end.

Political questioning of BoE independence likely reinforces both that and a sharp reversal late next year.

"Even though this seems a call for tougher action now, a deep recession in the years before the general election is unpopular too," Koopman said. "This will put the central bank on collision course with 10 Downing Street."

Brian Nick, Chief Investment Strategist at Chicago-based asset manager Nuveen said the Bank of England had "no good options" right now but rumblings about its inflation mandate and independence would only complicate the situation even more.

"History suggests that (removing the BoE's independence) would be a mistake. This is an extremely challenging time for central banks, partly due to their own errors in 2021 but primarily due to circumstances beyond their control."


Against that backdrop, Thursday's BoE interest rate hike, the biggest in more than a quarter century, was almost a sideshow.

To be fair, the move had been well flagged and merely aped a growing hawkishness among the Bank's peers around the world in tackling decades-high global inflation. The initial market reaction was fairly subdued.

Even though the BoE was the first of the G7 central banks to start raising interest rates late last year, its main policy rate remains lower than the equivalent in the United States, Canada and Australia.

That lag is best explained by the Bank's apocalyptic forecasting around Thursday's hike - an outlook markets will find much harder to brush off over the remainder of the year and painting Britain as a likely outlier among rival economies.

The Bank now sees inflation peaking above 13% in October just as a mammoth five-quarter recession unfolds - the longest UK downturn since the banking crash 14 years ago, involving a two percent contraction of output and almost doubling the unemployment rate to more than 6%.

Fears of a 'scorched earth' policy were echoed in the Bank's own forecast that inflation will eventually plummet back below 1% by 2025.

Which way to turn? It may get dizzy.

For all his attempts on Thursday at sounding resolute on getting inflation back to target with 'no ifs and buts', BoE chief Andrew Bailey went on to suggest the risks to these forecasts were "exceptionally large".

"It's hard to recall a bleaker outcome to a central bank meeting," said Nick at Nuveen.

The pointed political backdrop will not make the job any easier.

The author is editor-at-large for finance and markets at Reuters News. Any views expressed here are his own

(by Mike Dolan, Twitter: @reutersMikeD; Editing by Kirsten Donovan)