BOE governor concerned over risks of persistent UK inflation

BANK of England (BOE) governor Andrew Bailey and his colleagues said there were risks that inflation could remain well above the UK’s 2-per-cent target for some time.

In testimony to the Treasury Committee in Parliament on Thursday (Feb 9), he said that he expects inflation to fall sharply this year, but that there are risks around that forecast. 

Lawmakers on the panel quizzed members of the nine-member Monetary Policy Committee (MPC) about why they allowed inflation to soar to a 41-year high of 11.1 per cent last year.

Following are the key developments from the hearing.

Bailey says UK may have turned corner on inflation

Bailey said that he expects inflation to fall sharply this year, and that “I do think we’ve turned the corner in terms of headline inflation. It has not only fallen, it’s now under what we thought it would be in November”.

“But we need to see more evidence that this process will take effect.”

Bailey hopeful labour market is loosening

Bailey said there are “early signs” of the labour market cooling, but that any loosening will not trigger a wave of job losses.

SEE ALSO

UK faces bleakest outlook in generations as more Britons stop working

UK steps up planning for digital pound currency backed by BOE

He told lawmakers that a loosening of the tight jobs market will come through as a decline in vacancies and hours worked, rather than higher unemployment.

Companies are “reluctant to shed people, and they’re more thinking in terms of reducing hours rather than heads”, Bailey said. He added that companies slashing hours for workers rather than letting them go will have a “milder effect” on the economy.

Silvana Tenreyro says UK rates remain too high

Silvana Tenreyro, an external member of the Bank’s MPC, told lawmakers that she thinks the bank’s 4 per cent base rate is “too high” when combined with falling commodity prices – and that only a fraction of the MPC’s tightening had currently fed through to the economy.

“Unless there is another big development that we don’t know about, then I think the fall in inflation is pretty much guaranteed,” she said. “It takes time for changes in the bank rate to feed through,” and that only about a fifth of the bank’s string of 10 rate hikes has currently come through.

“The impact of monetary policy, combined with this unwinding in energy and other commodity prices, should be enough to get us not at target, but below target in the medium term,” she said. “That’s why, in my view, rates are too high.”

Tenreyro says ‘massive recession’ needed to halt inflation

Tenreyro said it would have taken a “massive recession” to bring inflation down to the 2-per-cent target last year due to huge price rises in global goods-and-commodities markets.

“To meet the 2-per-cent inflation target in 2022, we would have needed services deflation of 15 per cent,” she told lawmakers. “This would require a massive recession, with unemployment at two-digit levels.”

The remarks explain why she has been supporting no change in interest rates.

Bailey concerned about ‘persistence’ in inflation

Bailey said he is “concerned about the persistence” of high inflation, but argued that all central banks were hit by a series of shocks after the Covid pandemic.

He noted that there first was a supply-chain shock after the Covid lockdowns, followed by an energy shock due to Russia’s invasion of Ukraine, and thirdly the UK’s labour-market shock. Bailey said the combination of events meant the usual expectation that individual supply shocks would “work its way through the system” did not happen.

The UK is also facing a unique labour market problem, as people drop out of work. “There has been a decline in participation,” he said. “Many countries had a decline in participation. What differentiates the UK is that it hasn’t recovered.” He added that he “can understand” why polling suggests that the public is not confident that the BOE is on top of the inflation shock.

Jonathan Haskel sees upside risks to inflation forecast

MPC member Jonathan Haskel wrote in an annual report to the Treasury Committee that there are “considerable risks to the upside” on inflation, relative to the BOE’s central forecast.

“The MPC included a historically-large upside skew to the forecast profile of inflation in the November 2022 Monetary Policy Report, and increased that in the February 2023 report,” he wrote. “Personally, I find my expectations for inflation to be towards the upper part of that distribution.”

He added that the current pace of wage growth of around 6 per cent to 7 per cent is inconsistent with the BOE’s 2-per-cent inflation target without a big improvement in productivity. Core inflation and services-sector price increases suggest that there is “considerable persistence in the inflation process”.

His conclusion was that, “economic theory suggests that uncertainty around the persistence of inflation should be met with more forceful action, and so I shall remain alert to indications that inflation is more persistent than we expected, and act forcefully if necessary”.

BOE chief economist expects ‘extended period of weakness’ in UK economy

BOE chief economist Huw Pill, writing in an annual report to the Treasury Committee, said that he expected an “extended period of weakness” in the UK economy, as interest-rate increases start impacting activity.

“We are now seeing some signs of loosening in the labour market data: vacancies are falling, and some leading indicators of wage developments are easing,” he wrote in a note to the panel. “The slowing in economic activity seen in H2 2022 is working its way through into the labour market, while also reducing corporate pricing power.”

He added that with inflation above target, “there is no room for complacency”. BLOOMBERG