Bank of England Governor prepares us for possibility of 0.5% base rate increase

Andrew Bailey, Bank of England Governor, gave a speech yesterday at the Mansion House Financial and Professional Services Dinner. Although he did not and could not give an indication of what the Monetary Policy Committee’s decision would be for the next Bank Base Rate vote on the 4th of August, he was preparing the way for a potential 0.5% increase to not come as a surprise.

Bailey confirmed: “Our job is to hit the inflation target, and in the current circumstances to return inflation to target, always remembering the importance of understanding time lags in policy, and lags in the impact of economic shocks. Let me be quite clear, there are no ifs or buts in our commitment to the 2% inflation target. That’s our job, and that’s what we will do.”

Talking of the current major economic disturbances affecting monetary policy Bailey said: “The Russian shock is now the largest contributor to UK inflation by some way. There is an economic cost to the war, and we all have to recognise that, but at the Bank it will not deflect us from setting monetary policy to bring inflation back to the 2% target.”

Going on to the second current concern for monetary policy Bailey went on to say: “The UK labour force has shrunk over the last two years, and this is contributing to inflationary pressure due to the difficulty of recruiting. A one percentage point reduction in the labour force may not sound much, but with a working-age population of around 40 million it is a lot of people. With such numbers, the shrinkage in the labour market adds an inflationary impulse on top of energy and international goods prices. And central to the assessment of the outlook for monetary policy, it increases the risk that the inflation that has come to us from abroad gets embedded in more persistent domestic inflationary pressures.”

“Monetary policy has to be set taking into account the scale of this shock to real income, while keeping our focus on inflation and inflation expectations. Returning inflation to its 2% target sustainably remains our absolute priority. But we recognise a trade-off in a situation of high inflation and weakening growth. In my view this trade-off explains why we have raised Bank Rate progressively since last December in increments of 0.25% after the first rise. We have judged what we need to do in the face of these very big external shocks which, assuming Bank Rate following the market path used for the May MPR forecast, will see inflation fall very rapidly next year, and return to target in 2023, and then go below target.”

“But other things may not be equal, and we have been clear that we see the balance of risks to inflation as on the upside. Here, I would pick out the risks from domestic price and wage setting, and this explains why at the MPC’s last meeting we adopted language which made clear that if we see signs of greater persistence of inflation, and price and wage setting would be such signs, we will have to act forcefully”

The warning then came: “In simple terms, this means that a 50 basis point increase will be among the choices on the table when we next meet. 50 basis points is not locked in, and anyone who predicts that is doing so based on their own view. We do not pre-announce Bank Rate decisions for the very simple reason that MPC decisions are based on deliberation at the time among nine people focused on returning inflation to the 2% target sustainably.”

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