Bank of England Governor Andrew Bailey said that two months of declines in the UK’s headline inflation rate is a signal that the economy may be getting past the worst in a cost-of-living squeeze.

It’s “the beginning of a sign that a corner has been turned,” Bailey said in an interview with the Western Mail published on the BusinessLive website on Thursday (Jan 19). “What we think is the most likely outcome is that it (inflation) will fall quite rapidly this year, probably starting in the late spring, and that has a lot to do with energy pricing.”

The comments suggest central bank officials may be considering when to let up on the quickest monetary tightening cycle in three decades. Policy makers have lifted the key lending rate nine times since December 2021 to quell soaring prices that have squeezed household budgets.

While he said the BOE remains concerned about inflationary pressures in the labour market, he noted some signs that rapid wage growth may be about to cool.

“At the moment I think the news on pay – yes there are some signs that if anything it is still rising a bit – but some of the forward looking surveys of earnings and pay are not as strong as that actually,” Bailey said. “We are extracting every piece of information that we can possibly find.”

Official figures this week showed inflation cooled for a second month in December, falling to 10.5 per cent from a 41-year high of 11.1 per cent in October. Another report showed wage growth hit the highest on record except for the period right after the pandemic started.

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The governor warned that economic activity is sluggish enough to prompt what’s likely to be a “long but shallow recession.” He remains concerned about the tightness of the labour market and the impact that will have on inflation. 

“I have been in South Wales talking to firms and get a lot of stories, as I do when we go to other parts of the country, that even though activity in the economy has been quite weak in recent times, the labour market remains very competitive and that is influencing pay negotiations,” Bailey said.

He noted that the UK is suffering “a quite unprecedented and quite unique fall in the labour force” because of at least 500,000 people dropping out of the workforce since the pandemic. 

“Unemployment has ticked up a little bit, but it is still at historically low levels,” Bailey said. “We have had a rise in inactivity and the labour force has shrunk, and that is putting pressure on the labour market” that’s leading to higher wages and inflation.

Bailey suggested that market interest rate expectations are now more closely aligned with the BOE’s thinking on where borrowing costs peak. Investors are betting on another 1 percentage point increase in the benchmark lending rate to 4.5 per cent – including a half-point hike in February.

“I am not endorsing 4.5 per cent, but what you may have noticed in December is that we did not include the comment that we made in November about the market being in our view rather out of line,” Bailey said. 

He emphasised the UK is still recovering from the Covid pandemic and that the outlook is more unsettled than usual.

“People always talk about the rapid recovery from the worst of Covid,” Bailey said. “The economy went off a cliff and it came back up some of the cliff, but since then it has been a pretty grinding process.” BLOOMBERG