Market News

The Bank of England (BoE) may need to keep higher interest rates for longer than markets are currently pricing in, as inflation could prove more persistent than anticipated, according to the central bank's chief economist.

Huw Pill warned that bringing inflation back to the BoE’s 2% target might be more challenging than expected. "[This could] mean that the response of monetary policy, to ensure that we get back to our target within a reasonable cycle, needs to be somewhat more aggressive or more persistent in itself,” he said, according to Reuters.

He warned the risk of second-round inflation effects, as well as concerns that the UK might be undergoing a structural shift in the way prices and wages are set. These developments could potentially lead to higher inflationary pressures in the medium term.

In a speech at the London School of Economics (LSE), Pill told investors not to take the BoE's latest forecast – suggesting inflation would return to target by early 2027 based on current market pricing – as an endorsement of future rate cuts. Pill made clear that the BoE’s forecast was not a signal for an imminent reduction in rates, as market expectations have indicated.

Pill, a member of the BoE’s monetary policy committee (MPC), was one of the committee members who voted against reducing rates to 4.25% last week. Instead, he favoured keeping them unchanged, reflecting his cautious stance on the outlook for inflation.

The market is pricing in a cut in interest rates of up to 48.6 basis points in total by the end of the year, with no change in policy at the next BoE meeting in June.

The chief economist also expressed concern about weak productivity growth, pointing to the BoE’s more inflationary scenario, which could indicate further challenges in controlling price rises. He drew parallels to past inflationary periods, noting that the recent surge in wage demands could mirror the dynamics of inflation crises from the 1970s and 1980s.

"I remain concerned that we have seen a sort of structural change in price and wage-setting behaviour, maybe driven by the type of things that were involved in models of the inflation process from the '70s and '80s," he said.

UK pay growth slowed in the three months to March, with the jobs market also showing signs of cooling, amid heightened economic uncertainty.

Average regular earnings excluding bonuses rose 5.6% in the period on an annual basis, according to data from the Office for National Statistics (ONS). That was down from 5.9% in the three months to February, but still easily outstripped inflation, which fell to 2.6% in March.

Annual growth in real terms – adjusted for inflation – fell to 1.8%, compared with 2.1% in the previous quarter.

On Monday, two BoE policymakers cautioned about further interest rate cuts, following last week's quarter-point reduction, as wage and inflation measures remain too high.

Clare Lombardelli, deputy governor of the BoE, and Megan Greene, an external member of the MPC, both said that while they supported the decision to lower interest rates to 4.25%, they were reluctant to take further action without more evident signs of inflation subsiding.