The Bank of England’s chief economist on Monday warned that the UK faces a more serious threat of persistently high inflation than other advanced countries, signalling interest rates might have to stay higher for longer.
In a hawkish speech in New York, Huw Pill suggested the UK’s “distinctive” inflation problem combined the worst of both US and European pricing problems.
He said the BoE initially had to deal with a surge in natural gas prices, but the risk of inflation staying high was compounded by low unemployment, Britons quitting the jobs market, and companies finding it relatively easy to raise the cost of their products.
In response, Pill said the central bank’s Monetary Policy Committee had raised interest rates from 0.1 per cent in December 2021 to 3.5 per cent last month, in nine consecutive increases, but this was unlikely in his view to be enough.
Stressing the “persistence” of inflationary pressure in the UK as being of key importance, Pill, an MPC member, added: “The distinctive context that prevails in the UK — of higher natural gas prices with a tight labour market, adverse labour supply developments and goods market bottlenecks — creates the potential for inflation to prove more persistent.”
He said this combination was what “will strongly influence my monetary policy position in the coming months”.
Pill set out three inflation challenges that central banks had to deal with across the world: raising interest rates from ultra-low to more normal levels, the ability of companies to raise prices and tight labour markets pushing up pay levels, and an energy shock stemming from Russia’s invasion of Ukraine.
He said all advanced countries faced the first problem, the US and UK had to deal with the second, and European countries were still struggling with the third, even though wholesale energy prices had fallen sharply in recent weeks.
“None of these challenges is unique to the UK,” added Pill. “But — at least in the way I have described it — the UK is distinctive in facing all three of these challenges at the same time.”
Economists expect UK inflation to have peaked at 11.1 per cent in October and for the rate to fall sharply this year as energy price rises drop out of the annual comparison.
But with unemployment close to a 50-year low, private sector wages growing at an annual rate of close to 7 per cent and companies expecting to raise prices sharply again this year, Pill was concerned that inflation would remain well above the BoE’s 2 per cent target for too long.
He said this persistence of high inflation was damaging and would lead to the BoE having to increase interest rates even further and keep them high.
Pill added the MPC was committed to “respond forcefully” if there was a threat of persistently too high inflation.
“The scope for energy price rises to trigger the infamous second round effects in price, wage and cost dynamics . . . is greater when the corporate sector enjoys pricing power and the labour market is tight,” he said.
Financial markets expect the BoE to raise interest rates by another percentage point to 4.5 per cent by this summer and to keep them at that level until spring 2024, but not to drop below 4 per cent until the end of next year.