Bailey: We will get inflation down
Harriet Baldwin MP continues to challenge the Bank over its record in controlling inflation.
Q: Inflation was running at 6% in this country on the day Russia invaded Ukraine, and interest rates were at 0.5%. Do you think now that the risk to inflation was always more to the upside than downside, given monetary policy at the time?
Andrew Bailey says the Bank of England was still ‘wrestling’ with the question about how transitory the shocks hitting the UK economy would be.
We changed our view on that as we went through the summer, the BoE governor adds.
Q: How can people be confident that the Bank has made the right judgements, at the right time? Public polling shows there’s quite a high degree of public dissatisfaction over the Bank’s track record.
Governor Bailey says he can “quite understand” the public polling.
Our job is to get inflation back down to target.
The public will, of course, expect us to do that. And we will do it.
I’d expect that to be reflected in public polling, he adds:
I would, of course, expect the public to say ‘it’s your job to get inflation down to target’ and my response is ‘yes it is, and we will do it’.
Baldwin won’t let the governor get away with that!
“Actually, it’s your job not to let inflation get to this level of second-round effect”, she points out. [’second round effect’ mean the increase in wages as workers chase inflation-matching pay rises].
Bailey challenges this, insisting that there are plenty of first-round effects driving inflation at the moment.
The Bank expects annual inflation rate to fall this year, as ‘base effects’ unwind (as we catch up with price surges a year earlier).
Bailey predict inflation will be below 5% by the end of this year.
Please forgive the committee for being “slightly sceptical”, Baldwin shoots back, given how often the Bank’s projections have been incorrect in the past.
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Tenreyro: I would consider voting to cut rates
Bank of England rate-setter Silvana Tenreyro says she would consider backing a cut in interest rates.
She repeats her earlier point that interest rates are too high, as most of the tightening of policy has yet to feed though.
Tenreyro, who voted to leave interest rates at 3.5% last week, tells the Treasury committee she won’t commit to the timing of such a vote:
“Where things stand right now, I would see myself considering a cut.
I don’t want to talk about the particular meeting, because meeting to meeting doesn’t make much of a difference.
The Bank’s next interest-rate meeting is in late March. The money markets suggest a quarter-point rate rise, to 4.25%, is a 55% chance, while ‘no change’ is a 45% possibility.
Bailey won’t say he’s ‘vindicated’ over pay rise warning
Andrew Bailey is then asked whether he feels ‘vindicated’ after calling for workers not to seek big pay rises a year ago.
That was in the context of “excessive pay rises” that were ahead of inflation, the BoE governor replies firmly.
He explains that the energy price shock has made the UK poorer.
Unfortunately the nature of the UK’s terms of trade shocks are that the country is worse off, as a whole.
No I won’t say I’m vindicated. It is a very difficult situation for people in this country, particularly for those on low incomes.
Q: What is your message to the public, given you’ve raised interest rates again this month despite predicting that inflation has peaked?
Andrew Bailey replies that he does think inflation has ‘turned the corner’, as it is lower than expected back in November.
Plus, ‘very strong negative base effects’ (the surge in energy prices a year ago) will bring inflation down this year.
But, he reiterates, there is ‘substantial uncertainty’ over where the labour market, and price-setting, are going.
His view is that the risks are to inflation being higher than forecast – thus another rate rise was justified.
Huw Pill also says it’s possible that public sector pay rises at, or above, the rising cost of living would add to inflation.
The bank’s chief economist says:
There is certainly the potential for that to happen.
If that happens, our job is to ensure it does not lead to inflation, by responding to it with tighter monetary policy.
It’s not unreasonable to look for perfection from the Bank of England, says chief economist Huw Pill.
Pill, who joined the Bank in September 2021, tells the committee:
Of course we strive for perfection, but we will fall short.
Pill argues that the Bank has got “the big questions right” – by starting to raise interest rates at the end of 2021, and then accelerating that tightening in response to the energy shock.
Pill then warns of the risk of doing too much on interest rates, and ‘oversteering’ the economy.
Q: What would be the impact on inflation if the government agreed inflation-matching public sector wage claims, paid for through borrowing?
Andrew Bailey says this would cause a stimulation, due to fiscal effects. And the Bank would have to take that into account in its decisions.
Bailey says:
So yes, it would have an effect if we do that.
Q: Would that effect include higher interest rates?
Bailey says he only wants to “lay out the channels”, as this is a “very sensitive subject”. He’s not advocating government policy.
Bailey: inflationary impact of public sector pay rises depend on how it’s funded
Q: What are the inflationary risks from public sector pay rises? Would that fuel wider inflation?
Andrew Bailey says that there is “quite a big wedge” between public and private sector pay increases (with the public sector lagging far behind).
The impact of public sector pay rises, the governor explains, depend whether it is funded by borrowing or taxation.
Bailey says:
In terms of demand effects, it does depend how it’s funded.
Bailey says the Bank doesn’t want to wade into this territory, and he ‘isn’t advocating anything’, but…
The economics of it, depend whether you raise taxes or whether you borrow, frankly.
Andrew Bailey then defends last week’s interest rate increase, saying there is “substantial remaining uncertainty” over domestic inflation.
He cites the rise in inactivity in the labour market, as some workers (often the over-50s) have left the jobs market. That will lead to upward pressure on wages, as firms try to find workers.
Bailey says he does believe the UK has ‘turned the corner’ on inflation, but needs to see more evidence that this is happening.
Tenreyro: interest rates are too high.
Silvana Tenreyro is then asked why she voted to leave interest rates at 3.5% at last month, opposing the rate rise to 4%.
Tenreyro explains that monetary policy works with a lag – only a fifth of the previous monetary policy tightening have actually reached the real economy, she says.
“In my view, yes, rates are too high right now.
That’s why I didn’t support the vote.
Q: How confident is the Bank that inflation will fall this year, Conservative MP Anthony Browne asks.
Jonathan Haskel says the Bank’s forecasts, released last week, show inflation dropping from 10% at the start of 2022 to around 4% by the end.
We can be ‘reasonably confident’ that energy prices will fall, due to the way Ofgem’s price cap works, Haskel says.
But if there were another significant shock (as Andrew Bailey warned earlier), inflation could pan out differently.
Silvana Tenreyro agrees that the fall in GDP is pretty much guaranteed, due to the factors she explained earlier – unless there is an external shock.
Tenreyro says:
“Unless there is another big development that we don’t know about – and we have a massive energy shock or something that is not on the cards – then I think they fall in inflation is pretty much guaranteed.”
MPC member Jonathan Haskel points out that the Bank of England was worried about the Omicron variant of Covid-19 last winter.
Haskel reminds the committee that Omicron was a “major threat” at that time.
We now know that the vaccine was robust against Omicron, but we didn’t know that then.
Haskel explains that the Bank took advice from England’s chief medical officer, Chris Whitty, “the best advice in the land”.
Haskel says he asked Whitty what would happen if Omicron had escaped the vaccine, as had been feared when it emerged in South Africa.
Whitty explained that if that happened, the vaccine would need to be reengineered, which would take three to six months, and the vaccination programme would need to begin again. Fortunately that didn’t happen.
Tenrehro: Three reasons why inflation will come down
Q: The Bank’s monetary policy report shows services inflation at a new high. Haven’t second-order effects become much more deeply embedded in the economy, and won’t they be much harder to remove?
MPC member Silvana Tenrehro explains that to hit the Bank’s 2% inflation target, services inflation must come down, from 6.8% at present to 5%. That is possible, she says, for three reasons.
She explains that inflation in areas of services which are not energy-intensive has been below 5%. Naturally, as energy prices fall, there will be a direct slowdown in services inflation, she explains.
Second, there’s already signs of a slowdown in wage growth.
Thirdly – monetary policy will cool demand.
Professor Tenrehro explains:
We have tightened policy significnatly over the last year, and that’s going to have a large impact on demand and on the labour market.
That’s why the Bank is forecasting inflation will be below its 2% target in its latest forecast, she explains.
MPC policymaker Silvana Tenreyro tells the committee that the energy shock, not the tight labour market, was the main factor driving up inflation last year.
When inflation hit at 11% last year, eight percentage points came from energy. The remaining three percentage points came from services, she tells the committee.
So, to have inflation at the 2% target last year, service sector inflation would have been deeply negative – at around -15%, she has calculated.
Tenreyro explains to MPs that this would have required a major slump:
As you can imagine, deflation of 15% in services would require a massive recession, much bigger than after the great financial crisis.
Chief economist Huw Pill is now quizzed about his written testimony to the committee today, which points out that the Bank’s agents were flagging labour market tightness in autumn 2021 (leading to higher wage settlements), when the Bank was resisting raising rates.
Pill insists his testimony is consistent with Andrew Bailey’s explanation a few minutes ago for why the Bank didn’t start to raise interest rates until December 2021.
Pill says there were concerns that ending the furlough scheme would push up unemployment, with an estimated three-quarters of a million people on the programme.
Looking back…we faced a very specific and very uncertain environment in the labour market, associated with the end of the furlough scheme.
Pill says he favoured waiting for official unemployment data to come in, at the end of 2021, which showed that ending furlough had not pushed up joblessness.
Baldwin’s point is that there was contemporaneous evidence, from the Bank’s own agents around the UK, that the labour market was strong.
Bailey: We will get inflation down
Harriet Baldwin MP continues to challenge the Bank over its record in controlling inflation.
Q: Inflation was running at 6% in this country on the day Russia invaded Ukraine, and interest rates were at 0.5%. Do you think now that the risk to inflation was always more to the upside than downside, given monetary policy at the time?
Andrew Bailey says the Bank of England was still ‘wrestling’ with the question about how transitory the shocks hitting the UK economy would be.
We changed our view on that as we went through the summer, the BoE governor adds.
Q: How can people be confident that the Bank has made the right judgements, at the right time? Public polling shows there’s quite a high degree of public dissatisfaction over the Bank’s track record.
Governor Bailey says he can “quite understand” the public polling.
Our job is to get inflation back down to target.
The public will, of course, expect us to do that. And we will do it.
I’d expect that to be reflected in public polling, he adds:
I would, of course, expect the public to say ‘it’s your job to get inflation down to target’ and my response is ‘yes it is, and we will do it’.
Baldwin won’t let the governor get away with that!
“Actually, it’s your job not to let inflation get to this level of second-round effect”, she points out. [’second round effect’ mean the increase in wages as workers chase inflation-matching pay rises].
Bailey challenges this, insisting that there are plenty of first-round effects driving inflation at the moment.
The Bank expects annual inflation rate to fall this year, as ‘base effects’ unwind (as we catch up with price surges a year earlier).
Bailey predict inflation will be below 5% by the end of this year.
Please forgive the committee for being “slightly sceptical”, Baldwin shoots back, given how often the Bank’s projections have been incorrect in the past.
Governor Bailey: Judgements have been ‘very difficult’ amid several shocks
Treasury committee chair Harriet Baldwin begins, by reminding the Bank of England’s top brass that inflation is five-times over their 2% target, with food inflation over 16%.
Q: Do you accept that the Bank has made mistakes in this tightening cycle, and raised rates too late and too slowly, so it will be harder to bring inflation back to target?
Governor Andrew Bailey says the Bank doesn’t have the benefit of setting policy with hindsight, and embarks on a long defence of the Bank’s strategy.
There have been several ‘very big shocks’ hitting the economy in the last three years, he points out. He cites the “supply chain shock” when the recovery from Covid began.
That shock peaked at the end of 2021, he says.
But, two other big shocks also hit the economy – including the Russia-Ukraine war, which has been the ‘dominating’ shock this year. He doesn’t think anyone could have predicted this conflict, until close to it actually happening.
Inflation is still expected to fall rapidly this year, Bailey says.
The third shock, Bailey says, is the UK’s labour market, where there has been a decline in labour market participation.
Bailey tells MPs:
We’ve got a very tight labour market, We’ve had a fall in participation and it hasn’t recovered.
Baldwin challenges this argument, pointing out that Bailey told the committee in May 2021 that there were “hotspots” in the economy. And yet the Bank left interest rates at the record low of 0.1% until the end of 2021, and kept its quantitative easing stimulus programme.
Bailey says these hotspots were due to the global supply chain shock, and the reopening of the UK economy. The Bank felt they were tempory, transient, effects, rather than permanent.
But, Baldwin points out, inflation had hit 5.1% by November – then the governor said he was ‘very uneasy’ about the situation, but the Bank left rates at 0.1% until December.
Bailey says the Bank was watching for the impact of ending the pandemic furlough scheme, and the effect of the Omicron, at the end of 2021.
He says the Bank has faced some ‘very difficult’ judgements, telling the committee:
We were seeking to balance these various conflicting and countervailing presures at that time, and to assess what was happening in the labour market as the million jobs on furlough unwound.
Those were very difficult judgements.
Bailey adds that the Bank of England was the first major central bank to start tightening monetary policy (when it raised rates to 0.25% in December 2021). Other central banks were facing these multiple shocks too.
This was a challenge that others were having too.
