BANK of England governor Andrew Bailey said it is “too early to declare victory” over inflation but the risks of persistent inflation appear to be receding, a sign he is growing more confident about further interest rate cuts.
Bailey said the “second round inflation effects appear to be smaller than we expected” and that “we are now seeing a revision down in our assessment of that intrinsic persistence, but this is not something we can take for granted,” according to a text of a speech he is due to deliver on Friday in Jackson Hole, Wyoming.
His comments appeared to suggest the BOE is growing increasingly comfortable with the inflation outlook. The UK central bank lowered its benchmark lending rate by a quarter point earlier this month to 5 per cent, the first reduction since the start of the pandemic.
His words offered no guidance on whether BOE officials will move again in September, when the US Federal Reserve is on track to join with loosening. Investors expect another cut from the BOE in November to 4.75 per cent, pricing the chances of a move next month at just one-in-five.
Instead, he reiterated the BOE’s guidance from November that some degree of restrictiveness in policy will have to remain until inflation is fully subdued. Before the last cut, the BOE said rates are tight enough that they would bear down on the economy even if they are lowered. The comments leave the impression that officials will move slowly in making reductions and keep an eye on how data is responding.
“We are not yet back to target on a sustained basis,” Bailey said. “Policy setting will need to remain restrictive for sufficiently long until the risks to inflation remaining sustainably around the 2 per cent target in the medium term have dissipated further. The course will therefore be a steady one.”
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Sterling had risen 1 per cent after Fed chair Jerome Powell said Friday (Aug 23) that “the time has come for policy to adjust,” all but confirming lower rates are on the way in the US next month.
The pound held onto the gains following Bailey’s comments, trading at its highest in more than two years and lurching above US$1.32. The European Central Bank eased borrowing costs in June and is expected to move again in September.
Having brought UK inflation down from its peak of 11.1 per cent in late 2022, the BOE expects it to rebound by the end of the year. Inflation dropped to the 2 per cent target in May, where it remained in June.
It rose to 2.2 per cent in July and the BOE sees it bouncing back to 2.8 per cent by December due to higher energy bills. On Friday, the regulator Ofgem announced that household bills will increase by 10 per cent in October to £1,717 (S$2951.09) for the typical household.
Despite the anticipated pick-up in price growth, Bailey appeared sanguine. “The economic costs of bringing down persistent inflation – costs in terms of lower output and higher unemployment – could be less than in the past,” he said in the text. The BOE anticipates a lasting fall in inflation back to the 2 per cent target in 2025.
“This is consistent with a process of disinflation which is steady and more in keeping with a soft landing than a recession induced process,” Bailey added. The UK economy has proved more resilient this year than expected, and inflation expectations “appear to be better anchored,” he said.
After the speech, Bailey was questioned about what he would do if deflation became the greater risk again, as it was after the 2008 financial crisis.
The BOE now has negative interest rates in its armoury to fight deflation, he said, but added: “I remain quite concerned about it. There was a wide discussion of views but we remain cautious about it.” The BOE has never used negative rates, which were developed during the pandemic.
He also expressed concerns about quantitative easing (QE), which reached £895 billion between 2009 and 2021 as the bank attempted to lift prices and boost growth.
BOE is now aggressively unwinding QE. “The problem with QE is the opposite. Nobody understands it. QE is obscure,” Bailey said.
In his speech, Bailey acknowledged that the BOE could have done a better job with the £450 billion injection of QE during the pandemic, which was presented at the time as both a financial stability instrument and monetary policy tool.
“How to structure and communicate the policy response by central banks in this situation deserves more attention,” he said. He recognised that “some would still say we did too much,” but that he disagreed with their assessment.
The huge initial £200 billion QE injection helped stabilise markets in the extreme “dash for cash” period in March 2020, when non-banks such as hedge funds as well as banks needed support. The BOE is developing emergency liquidity tools for non-banks, Bailey said during questions, but stressed that the BOE would not be creating a standing facility for non-banks, as it has for banks.
“I would stress the point that we are not in any way contemplating standing facilities for non-banks,” he said. BLOOMBERG
