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Interest rates: Bank of England's Bailey warns UK inflation still stubborn - YAHOO FINANCE

FEBRUARY 02, 2023

BY  Pedro Goncalves·Finance Reporter, Yahoo Finance UK

The Bank of England believes that worst of prices rises are behind us but it is too early to declare victory on inflation.

Governor Andrew Bailey said in a press conference that the Bank had seen “the first signs that inflation has turned the corner” since its last Monetary Policy Report in November.

He highlighted that UK consumer price inflation fell to 10.5% in December, from 11.1% in October.

However, he warned that inflation could not fall below the 2% target at the start of next year if energy prices don't go down.

Bailey also warned that for inflation to fall higher wage expectations must not become embedded among the workforce.

“It is too soon to declare victory just yet. Inflationary pressures are still there,” the governor said.

Deputy governor Ben Broadbent told reporters that the BoE is also concerned about pricing.

Read more: Bank of England raises interest rates to 14-year high of 4%

“It’s not simply about wages. And the truth is, when they bid each other up, we don’t end up better off.”

Markets believe that the central bank might start to ease off this summer with hikes, a sentiment that Bailey did not refute.

Bailey said: “The extent to which inflationary pressures ease will depend on the evolution of the economy and the impact of the significant increases in Bank Rate so far.”

He added: “If there were to be evidence of more persistent pressures, then further tightening of monetary policy would be required.”

But he said that the Monetary Policy Committee had softened its language on future rises in interest rates because the economy is turning a corner on inflation.

“I think that reflects that we have seen a turning of the corner, but it’s early days and the risks are very large. And it’s really that which shapes where we go from here.

“If those risks emerge and if we continue to get overshoots as we’ve seen, particularly in the wage settlement data and services inflation, then we will have to respond to that, because that would be evidence that these risks are crystallising.

“If the economy were to evolve as the central case of the forecast suggests then we would have to re-evaluate as we always do.”

Alexander Batten, fixed income portfolio manager at Columbia Threadneedle Investments predicts the Bank of England is close to ending its interest rate increases.

He said: "The Bank’s forward guidance has been watered down even further. Language around forceful hikes, i.e 50bp or higher, has been removed, and more tightening has been tied to evidence of more persistent inflationary pressures appearing. The Bank have indicated the data they are looking at for this point – wages, services inflation and inflation expectations.

"The soft data suggests a significant weakening of the labour market ahead but we suspect this may not come soon enough to prevent one final 25bp hike in March."

Moody’s Analytics economist Thomas Sgouralis says today’s rate rise won’t be the last in this cycle.

“The Bank of England has raised rates from 3.5% to a 14 year high of 4%, the tenth consecutive increase in the policy rate since December 2021, underscoring its fight against inflation in the UK, which is the highest among G7 economies.

"Despite inflation showing signs of moderation, and with an economy that is vulnerable, today’s meeting is unlikely to be the end of the tightening cycle. We expect the BoE to take the policy interest rate to 4.5% before it pauses, since inflation is expected to start declining significantly from the middle of the year forward as the energy costs and consumption ease.”

Hit from Brexit coming faster than expected

Broadbent also said the impact of Brexit on the economy was coming through faster than first expected.

He said it was not clear if Brexit effects were a reason why the UK is forecasted to do worse than other major economies this year.

The International Monetary Fund (IMF) warned earlier this week that Britain would be the only major economy to see a contraction this year and the Bank said it also saw output for the UK this year being weaker than the eurozone or US.

Broadbent said Brexit was one factor impacting the UK economy, but also a shrinking labour market, higher dependency on gas than other countries and a greater pass through of interest rates to borrowers.

Broadbent said: “Brexit… has been something that has pulled on our potential output in our country and that’s been our assessment for many years.

“We’ve not changed our estimate of the long-running effects, but we’ve brought some of them forward and we think they’re probably coming in faster than we first expected.”

He added: “Yes it’s (Brexit) having some effect on growth, although ultimately no bigger effect than we assessed some years ago.

“Based on the numbers for trade and some degree for the numbers on investment, we think these effects are coming through faster than initially envisaged.”

The UK is set to enter recession this year but it will be shorter and less severe than previously thought, according to the Bank of England.

The slump is now expected to last just over a year rather than almost two as energy bills fall and price rises slow.


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