Bank of England governor: ‘We have good reason to expect inflation to fall sharply’
Bailey renewed his mantra about the Bank of England’s Monetary Policy Committee’s “job” in bringing inflation “back sustainably” to the 2% target (currently 10.1% in the year to March 2023).
He said this level of inflation which is “much too high” and “concentrated in the essentials of life” such as fuel, energy and food, is hurting the least well-off even harder because those staples are a much bigger share of their consumption than they are for the better-off.
Bailey also acknowledged that many people face difficult choices and have had to cut back on essentials.
“We know that higher interest rates make things hard for many people too. But we’re conscious that high inflation always hits the least well-off the hardest. Our job is to make sure inflation is low and stable, so we have had to raise rates to bring inflation back down”, Bailey said.
During his speech at the British Chamber of Commerce Annual Conference, the BoE governor also pushed back on the “one argument you sometimes hear” that inflation is high because monetary policy was too loose in the past.
“Even if we had had the benefit of full hindsight in the run-up to the war in Ukraine, and ample advanced warning – which for the record we did not, no one did – then in order to keep inflation at around 2%, we would have had to raise bank rate well into double digits, sending unemployment much higher than it is today, and we would have had to do so in the middle of the worst pandemic in more than a century.
“If we really could have followed this course on monetary policy, and then there had not actually been any subsequent increase in import prices, inflation would have fallen steeply, well into negative territory. And real incomes would have suffered through lower wages as well as much higher unemployment,” Bailey said.
He added: “Monetary policy can’t make the impact on real incomes go away I’m afraid.”
‘Big supply shocks continue to shape economic & inflationary dynamics’
Bailey said the Bank must take action to ensure inflation falls as supply shocks abate – the global supply issues, Russia’s appalling war on Ukraine and its people, sharp rise in food prices and domestically, the “abrupt halt” to the UK labour supply growth.
Action is needed so that these external sources “do not cause persistent ‘second-round’ effects on domestic wage and price setting that could hold inflation up for longer”.
“That is why we have increased bank rate by nearly 4½ percentage points from December 2021, from 0.1% then to 4.5% now,” Bailey said.
Post-pandemic growth lull but positive outlook ahead
At the same time, the UK has been slow to recover from Covid. After the initial recovery in 2020, the level of economic activity (measured by monthly GDP), has failed to grow beyond its pre-pandemic level on a sustained basis, hovering around that level since early 2022 and falling slightly below in the latest release for March.
“That sets the UK apart from other advanced economies. Both the euro area and especially the US have more than recovered the economic ground lost in the pandemic”, Bailey noted.
However, there are reasons to be positive as “things are looking a bit brighter than they did a couple of months ago”, he said.
Towards the end of 2022, the MPC expected a shallow but long recession but based on the latest forecast, it suggested modest but positive growth and a much smaller increase in unemployment.
“There has been some recovery in labour market participation, especially amongst younger workers, and the number of vacancies has come down from very high levels. The ratio of the number of vacancies to the number of unemployed, a key measure of labour market tightness, has fallen as a result,” he said.
Inflation to fall sharply soon
He added that there are “good reasons to expect inflation to fall sharply over the coming months”, beginning with the April number to be released on 24 May.
Bailey explained that energy prices have fallen from their peaks, and that will now start to come through as lower inflation.
In the March release, the prices of electricity, gas and other fuels were more than 85% higher than a year ago, contributing more than three percentage points to headline inflation.
“That contribution is likely to drop significantly to about one percentage point in next week’s data for April as large increases in energy prices from a year ago drop out of the annual calculations.
“Looking ahead to the end of the year, if energy prices evolve as financial market prices now suggest, the contribution from energy will fall further. Towards the end of the year, energy prices should begin to pull overall inflation down rather than push it up as they have done over the past two years,” he said.
However, Bailey is “less sure” about the timing when it comes to food price inflation easing off.
“Global prices of wholesale agricultural commodities have come down since spring of last year, and food producer price indices have eased in recent months. Evidence collected by the Bank’s agents suggests that food producers expect food production costs to moderate. While this may take longer than we previously thought, we should expect this to feed through to consumer food inflation over the coming year,” he said.
The governor confirmed the MPC’s mean forecast path for inflation at or just below the 2% target at years two and three.