Bank of England governor Andrew Bailey on Wednesday signalled interest rates in the UK are likely to stay higher for longer than financial markets are expecting because inflation has proved to be such a persistent problem.
Speaking at a European Central Bank conference in Sintra, Portugal, Bailey suggested markets were wrong to think rates would fall quickly from a peak reached around the end of this year.
Bailey said the BoE would be “evidence driven” in setting the cost of borrowing and it was looking at both the peak of rates and “how long [the peak] sustains beyond that”.
“I’ve always been interested that markets think that the peak will be shortlived in a world [where] we’re dealing with more persistent inflation,” he added.
Financial markets have currently priced in UK interest rates rising from 5 per cent to 6.25 per cent at around the end of the year, before beginning to fall during the spring or summer of 2024.
However, expectations for rates in the summer of 2025 have shifted markedly higher over the past month, rising from 4.5 per cent to 5.5 per cent.
UK inflation remained stuck at 8.7 per cent in May, according to official data.
Bailey said the most important problem facing the UK was core inflation, which excludes volatile food and energy prices and is currently 2 percentage points higher than in the eurozone or the US.
“It’s core that’s the issue, it’s much stickier,” he added, citing a buoyant UK labour market and a fall in the size of the workforce after the Covid crisis.
Bailey said the BoE would not ask the government to make the central bank’s task of restoring price stability easier by raising the inflation target from its current 2 per cent level.
“We are facing the biggest challenge for a very long time, but we’ve got to meet that challenge,” he added.
He refused to comment on whether his task would be made easier if the government raised taxes or cut public spending to damp demand and spending in the UK economy.
But he struck a different stance to that of BoE chief economist Huw Pill by suggesting there was a virtue in the central bank’s forecasts being partly based on announced government policies on tax and spending.
“We always, when setting monetary policy, take fiscal policy as announced,” said Bailey.
By contrast, Pill highlighted how the BoE had got its August 2022 forecast of a UK recession wrong, partly because it assumed the government would not provide any support for households struggling with high energy bills.
At the time of the forecast, the government had not announced support, but it went on to provide a cap on gas and electricity bills.
“What was particularly unlikely was energy prices being at this very high level for ever and yet there being no fiscal response,” said Pill at the same ECB conference.
The BoE this month announced a review of how it makes and uses economic forecasts, in an acknowledgment that it has made mistakes.
Source: Economy - ft.com
