Policymakers at the Bank of England have warned that markets are “underestimating” the risks that inflation will persistently above the two per cent target.
In a meeting of the Treasury Select Committee, four members of the Bank’s nine-strong Monetary Policy Committee (MPC) agreed that there were clear risks that inflation could remain elevated despite the sharp fall in October.
“I really think the market is putting too much weight on the current data releases,” Andrew Bailey, governor of the Bank of England said.
Although the headline rate of inflation fell to 4.6 per cent in October from 6.7 per cent the month before, Bailey pointed out that domestic price pressures remained strong.
“We are concerned about the potential persistence of inflation as we go through the remainder of the journey down to two per cent. I think the market is underestimating that,” he said.
Markets currently expect the Bank to start cutting interest rates in the summer of next year, with the benchmark Bank Rate expected to stand at 4.5 per cent by the end of 2024.
But MPC members have repeatedly stressed that it is too early to think about cutting rates. The divergence in opinion represents the Bank’s more “pessimistic” picture of the supply side, Dave Ramsden said. “That’s what giving us the sense that the last mile is going to be the hardest”.
In the Bank’s most recent Monetary Policy Report, inflation is only expected to return to two per cent at the end of 2025 despite falling to around three per cent at the end of next year. Other forecasters are more optimistic, predicting inflation will fall to around 2.4 per cent by the end of next year.
Rather than focus on the headline rate, the Bank has identified a handful of proxies for domestic inflation, such as services inflation and wage growth.
Jonathan Haskell, an external member of the MPC, suggested that markets “fail to appreciate that we consider a different set of measures” to the headline rate of inflation.
According to the most recent figures, services inflation stands at 6.6 per cent and wage growth at 7.7 per cent, both at levels inconsistent with inflation falling to two per cent on a sustainable basis.
Despite the difficulty in returning inflation to the target, Bailey was dismissive of the argument that the inflation target could be moved higher to reflect the difficulty in stamping out inflation.
It’s “a very bad argument”, Bailey said. “The next time we have this problem they’re going to say let’s call it four per cent,”