Feb 9, 2023
BOE’s Bailey Concerned Over Risks That UK Inflation Remains Persistent
(Bloomberg) -- Bank of England Governor Andrew Bailey and his colleagues noted the risks that inflation remain well above the UK’s 2% target for some time.
In testimony to the Treasury Committee in Parliament on Thursday, Bailey said he expects inflation to fall sharply this year, but there are risks around that forecast.
Lawmakers on the panel quizzed members of the nine-member Monetary Policy Committee about why they allowed inflation to soar to a 41-year high of 11.1% last year. Also testifying were Chief Economist Huw Pill and policy makers Silvana Tenreyro and Jonathan Haskel.
Key developments so far include:
- Bailey says public sector pay raises may lift inflation
- Tenreyro says interest rates “are too high” in UK
- Pill says BOE must guard against raising rates too far
- Haskel sees significant upside risks to CPI forecast
Following are the key developments from the hearing. Times posted are for London.
Bailey Says QT Not Producing Any ‘Market Disturbance’ (11:43 a.m.)
Bailey said asset sales under the BOE’s quantitative tightening program isn’t producing any “market disturbance.” He said it’s too soon to tell how much impact, if any, the sales are having on the economy or how they compare with interest rate increases.
“We’re not seeing any market disturbance and we look at the conditions in markets around the auctions. We’ve looked at measures of liquidity,” Bailey said
Chief Economist Huw Pill said the sales are likely to have an impact on bond yields, but he can’t say how much yet.
“I would expect the sale of these bonds to have some effect on market pricing along the yield curve,” Pill said.
Bailey Remarks on Scrapping Bank Bonus Cap (11:30 a.m.)
Bailey said that scrapping the bonus cap now that UK is outside the European Union will not increase risk and will improve incentives in the financial sector.
The BOE governor said the cap, which limits bonuses to twice annual salaries, simply increased permanent pay for bankers and created the wrong incentives around risk taking. It was a mistake at the time it was introduced and Britain is better off without it, he said.
“We think we have a better policy framework in ace and the bonus cap has the wrong incentives attached to it,” Bailey said. “We have had a UK policy framework in place which is consistent with the right incentives.”
“One is deferral of a good proportion of the variable remuneration (bonus). The other is malus – taking it back before it is given out, and claw-back which goes even beyond that,” he said.
In addition, the UK rules on remuneration require a large part of the bonus to be paid “in instruments that reflect risk and are not cash” like equity and convertible debt.
Haskel Says BOE Needs to Guard Against ‘Bad Outcomes’ (11:10 a.m.)
Haskel said the MPC needed to “guard very vigilantly against really bad outcomes,” which include inflationary momentum building and also very sharply under-shooting the 2% inflation target.
“I am super worried about going under the target, but, as I say, given the uncertainties at the moment, I’d rather put a rather little bit less weight on that medium-term forecast,” he said, adding that he was focused on short-term indicators such as redundancy numbers and jobs vacancies.
Pill Sees Economic Growth Near Zero This Year (11:04 a.m.)
Pill said Britain’s economy will “bobbing around the zero level” this year and faces a prolonged period of sluggish growth.
“I would a little bit get away from focusing on recessions, but I think we will see a relatively long period of weak growth and the fundamental driver of that is weakness on the supply side,” he told lawmakers.
The BOE upgraded its forecasts for the UK last week and expects a smaller 0.5% contraction in 2023. However, it also delivered a gloomier assessment on the UK’s growth prospects. It warned that persistently anemic productivity and weaker labor supply will hold back the supply side of the economy.
Pill sad the BOE has “a very shallow recession” penciled into its forecasts.
Pill Says Big Pay Raises Could Trigger Higher Rates (10:50 a.m.)
On public sector pay, Pill echoed Bailey’s comments and clarified that borrowing to pay for public sector pay rises would lead to higher interest rates. Doing so “implies monetary policy will be tighter to keep aggregate behaviour in the economy in line with price stability,” he said.
Pill Says BOE Must Guard Against Too Many Hikes (10:45 a.m.)
Pill said policy makers must both guard against raising interest rates too sharply and the prospect that inflation becomes embedded in the economy.
“We need to guard against doing too much with policy because there is a danger of over-steering if there are lags in transmission,” Pill said., “I think we should be watchful to these risks of greater persistence.”
Bailey Says Public Sector Might Spark Inflation (10:35 a.m.)
Bailey said public sector pay rises would be inflationary if the government borrowed to fund them. He acknowledged that a “wedge” has opened up between public and private sector pay but stressed it was not his job to wade into the political debate over rolling public sector strikes.
Government officials have in the past argued that awarding public sector workers big pay rises would be inflationary but Bailey said it would depend on how the wage increases are funded.
“The economics of it depends on whether you raise taxes or whether you borrow,” Bailey said. If the government borrowed to top up pay for public sector workers, of which there are 5.5 million in the UK, it would affect “overall demand in the economy.”
“There would be a fiscal impact – it would effectively cause stimulation through fiscal effects and we would have to take that into account.”
Bailey Says UK May Have Turned Corner on Inflation (10:32 a.m.)
Bailey said he thought inflation would fall sharply this year and that “I do think we’ve turned the corner in terms of headline inflation. It has not only fallen, it’s now under what we thought it would be in November.”
“But we need to see more evidence that this this process will take effect.”
Bailey Hopeful Labor Market is Loosening (10:31 a.m.)
Bailey said there are “early signs” of the labor market cooling but that any loosening will not trigger a wave of job losses.
Bailey told lawmakers that a loosening of the tight jobs market will come through as a decline in vacancies and hours worked rather than higher unemployment.
Companies are “reluctant to shed people and they’re more thinking in terms of reducing hours rather than heads”, Bailey said. He added that companies slashing hours for workers rather than letting them go will have a “milder effect” on the economy.
Tenreyro Says UK Rates Remain Too High (10.25 a.m.)
Tenreryo told lawmakers that she thinks the bank’s 4% base rate is “too high” when combined with falling commodity prices – and that only a fraction of the MPC’s tightening had currently fed through to the economy.
“Unless there is another big development that we don’t know about, then I think the fall in inflation is pretty much guaranteed,” Tenreyro said. “It takes time for changes in Bank rate to feed through,” and that only “about one fifth” of the bank’s string of 10 rate hikes has currently come through.
“The impact of monetary policy combined with this energy and other commodity prices unwind should be enough to get us not at target but below target in the medium term,” Tenreyro said. “That’s why, in my view, rates are too high.”
Tenreyro Says ‘Massive Recession’ Needed to Halt Inflation (10:15 a.m.)
Silvana Tenreryo, an external member of the Bank’s MPC, said it would have taken a “massive recession” to bring inflation down to the 2% target last year due to huge price rises in global goods and commodities markets.
“To meet the 2% inflation target in 2022, we would have needed services deflation of 15pc,” she told lawmakers. “This would require a massive recession with unemployment at 2-digit levels.”
The remarks explain why she has been supporting no change in interest rates.
Bailey Concerned About ‘Persistence’ in Inflation (10:06 a.m.)
Governor Andrew Bailey said he is “concerned about the persistence” of high inflation but argued that all central banks were hit by a series of shocks after the Covid pandemic
He noted there first was a supply chain shock after Covid lockdown, followed by an energy shock due to Russia’s invasion of Ukraine and thirdly the UK’s labor market shock. Bailey said the combination of events meant the usual expectation that an individual supply shocks would “work its way through the system” did not happen.
The UK is also facing a unique labor market problem, as people drop out of work. “There has been a decline in participation,” he said. “Many countries had a decline in participation. What differentiates the UK is that it hasn’t recovered.” He added that he “can understand” why polling suggests the public is not confident that the BOE is on top of the inflation shock.
Haskel Sees Upside Risks to Inflation Forecast (9:52 a.m.)
Jonathan Haskel wrote in an annual report to the Treasury Committee that he saw “considerable risks to the upside” on inflation relative to the BOE’s central forecast.
“The MPC included a historically-large upside skew to the forecast profile of inflation in the November 2022 MPR, and increased that in the February 2023 MP,” he wrote. “Personally I find my expectations for inflation to be towards the upper part of that distribution.”
He added that the current pace of wage growth around 6% to 7% is inconsistent with the BOE’s 2% inflation target without a big improvement in productivity. Core inflation and services sector price increases suggest there is “considerable persistence in the inflation process.”
His conclusion was that, “economic theory suggests that uncertainty around the persistence of inflation should be met with more forceful action, and so I shall remain alert to indications that inflation is more persistent than we expected, and act forcefully if necessary.”
Pill Sees ‘Extended Period of Weakness’ in UK Economy (9:52 a.m.)
BOE Chief Economist Huw Pill, writing in an annual report to the Treasury Committee, said he expected an “extended period of weakness” in the UK economy as interest rate increases start impacting activity.
“We are now seeing some signs of loosening in the labour market data: vacancies are falling, and some leading indicators of wage developments are easing,” Pill wrote in a note to the panel. “The slowing in economic activity seen in 2022 H2 is working its way through into the labour market, while also reducing corporate pricing power.”
He added that with inflation above target “there is no room for complacency.”
--With assistance from Philip Aldrick.
(Updates with remarks from Bailey and Pill.)
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