UK to suffer high inflation longer than other nations, warns Bailey

The governor of the Bank of England warned on Wednesday that Britain’s economy is suffering more from the energy crisis than other countries with UK inflation likely to stay higher for longer.

Speaking with other central bankers at a European Central Bank conference in Sintra, Portugal, Andrew Bailey said the BoE needed the option of half-point interest rate rises to address inflation but did not commit to further increases.

But he was adamant that the BoE would curb rapidly rising prices even if that meant pain for households. “The key thing for us is to bring inflation back down to target and that is what we will do,” Bailey said.

The governor’s comments underscore how necessary that he and the BoE think it will be for households to suffer financial pain if the UK is to bring inflation, which hit 9.1 per cent in May, to the target level of 2 per cent.

The BoE has said it expects inflation will rise over 11 per cent in the autumn.

Bailey declined to attribute the worsening economic outlook to Brexit or sterling’s drop against the dollar this year. But, he added, the fall in the currency had not surprised him because it reflected a weak UK economic outlook.

“I think the UK economy is probably weakening rather earlier and somewhat more than others,” Bailey said, attributing the problems to the energy price shock that all European economies faced alongside a UK problem of people dropping out of the labour market.

Bailey said that in the latest inflation data, he had seen a shift in the causes of high inflation from high prices of goods that were in short supply after Covid, towards goods and services affected by Russia’s invasion of Ukraine.

He said inflation would persist higher in the UK than elsewhere, lengthening the pain felt by households across Britain.

“Unfortunately, there is going to be a further step up in UK inflation later this year because that’s a product of the way the energy price cap interacts with the energy prices we have observed over the last few months,” Bailey said.

He said the energy price cap, which moves slowly to reflect gas price rises in the US, would widen the gap between higher UK inflation and lower rates in much of Europe later this year.

“I would imagine that will put a bit more persistence [into the UK inflation rate] and we will have to explain that,” Bailey said, noting that the BoE would be looking at the underlying price pressures in setting interest rates.

Monetary policy has been tightened from a 0.1 per cent rate in December last year to 1.25 per cent rate set in June. Financial markets expect rates to rise further to around 3 per cent in a year’s time.

Bailey said that this latest market expectation appeared steeper than previous BoE forecasts suggested because it contained a risk element, and that the risks to both inflation and to interest rates were still on the upside.

“I would agree with that,” he said referring to the markets properly pricing in the risk that rates would have to rise more than expected.

As Bailey was speaking in Portugal, Swati Dhingra, the LSE professor who will join the Monetary Policy Committee in August, took a more dovish tone in evidence to the Treasury committee, saying there was room to take a “very gradual approach” to raising interest rates, given the latest data on consumer confidence.

Dhingra said the decision to raise interest rates by 25, rather than 50, basis points last month showed the MPC was operating in a small range, relative to the bigger rate moves it had made at the time of the financial crisis.

She added that in light of the latest data — which showed consumer confidence at its lowest in a half century of records — she favoured a “very nuanced” response to the evolving situation.

Additional reporting by Delphine Strauss