The governor of the Bank of England said he was concerned about the risks of persistent inflationary pressure from a strong labour market, even though he expects economic activity to slow over the rest of the year.
Speaking on the sidelines of the IMF and World Bank spring meetings in Washington on Thursday, Andrew Bailey said he feared that the economy might fall into recession if the central bank raised interest rates too far.
Although the governor insisted that he was not sending precise signals about which way he would vote at a meeting of the Monetary Policy Committee in two weeks’ time, his comments suggest that he thinks interest rates need to rise further.
“We are walking this very, very fine line,” the governor said, describing the twin pitfalls that threatened the UK economy. One was the potential failure of the BoE to “tackle inflation” and the other was “the risk that [the rising cost of living and higher interest rates] creates a recession and pushes too far down on inflation”.
His comments about the possibility of recession suggested that he did not think interest rates needed to rise as fast as financial markets are anticipating. Traders are betting on the BoE raising rates aggressively from 0.75 per cent to 2.5 per cent by this time next year.
Speaking to the Peterson Institute for International Economics, Bailey said that the high UK inflation rate, which hit 7 per cent in March, was caused both by US-style overheating and strong demand, and the European affliction of high energy prices that could ultimately curb spending and inflationary pressure.
With these opposing threats, Bailey said he did not want to give too much forward guidance on the likely path of interest rates because economic conditions were changing so quickly.
“If we live in a world where one core energy price can fall 20 per cent in one afternoon, as it did last week, you feel pretty humble about the amount of guidance you can give on where policy will go,” he said.
The governor made clear his concerns that the series of upward price shocks over the past year, alongside a tight labour market, would fuel persistent inflationary pressures. This combination, he suggested, required more attention than normal from the central bank.
If there was “shock after shock” to prices, the central bank would have to worry more that companies would push through price rises to defend profit margins and employees would demand higher wages to compensate.
Bailey said the tightness of the labour market would add to immediate inflationary pressures. “This combination of supply shocks and a tight labour market tends to give us more of a problem [of persistent inflation],” he said.
“We think that the real income shock at the scale it is [currently], is going to cause a slowdown in growth . . . but the question is whether the labour market is going to slow down.”
He added: “We have to ask ourselves the question, well: is that going to cause the labour market to be stronger for longer, notwithstanding a decline in growth?”