Bank of England governor Andrew Bailey warns of uncertainty over inflation drop
The risk of inflation staying higher for longer than the Bank of England’s two per cent target than it expects is mounting due to the slow reduction of wage pressures and price rises, the Governor of the central bank warned today.
Speaking at the British Chambers of Commerce’s (BCC) annual conference, Andrew Bailey warned the Bank thinks the likelihood of inflation topping its projections is “skewed significantly to the upside”.
Economists on Threadneedle Street have arrived at that judgement because “the unwinding of second-round effects may take longer than it did for them to emerge,” he added.
“Our commitment to the two per cent inflation target is unwavering,” Bailey said, however.
Inflation has consistently breached the central bank’s projections, including in March when it hit 10.1 per cent, 0.8 percentage points over its prediction.
Bailey said if further inflation shocks emerge, “then further tightening in monetary policy would be required”.
The Bank’s base case scenario assumes interest rates will need to rise to the market’s expected peak of 4.75 per cent for inflation to eventually dip below the two per cent.
The Governor, alongside six other members of the nine-strong monetary policy committee (MPC), last week backed a twelfth straight interest rise, voting for a 25 basis points increase to 4.5 per cent, taking them to their highest level since October 2008.
Core inflation, a more accurate measure of underlying inflation pressures, also firmed in March, suggesting UK inflation is beginning to be driven by home-grown factors such as pay growth instead of international energy prices soaring after Russia’s invasion of Ukraine.
Those upside inflation shocks reflect “the possibility of more persistence in domestic wage and price setting,” Bailey said.
Last week, the Bank hiked its medium term inflation forecasts from its February projection.
It now thinks the rate of price increases will still be around five per cent by the end of the year, up from 3.9 per cent, and that it won’t return to its two per cent target until 2025.
That upgrade was primarily as a result of stronger than expected household spending and food prices accelerating at a historic pace of around 20 per cent.
Figures out next Wednesday from the Office for National Statistics are tipped to show inflation fell markedly in April to around eight per cent, mainly due to the big upside energy price contribution falling out of the calculation.
UK economic growth is now on course to be more than two per cent higher over the next few years than the Bank expected in February.
“Things are looking a bit brighter than they did a couple of months ago,” Bailey said. Just back in November, the monetary authority thought the country would suffer 15 straight months of economic contraction.
Though GDP growth is now likely to be much better, households are still being crimped by a tough cost of living crisis.
The Bank “can’t make this impact on real incomes go away,” Bailey said today.
Chief economist Huw Pill yesterday also apologised for asking families and business to accept their worse off earlier this month
“What we have to do is to take action to ensure that inflation falls as the external shocks abate – that inflationary impulses from these external sources do not cause persistent ‘second-round’ effects on domestic wage and price setting that could hold inflation up for longer,” Bailey said.