Huw Pill, the Bank of England’s chief economist, said on Friday it was “crucial” to prevent the UK from drifting deeper into “inflationary psychology”, in an indication he supports further interest rate rises.
With inflation reaching a 40-year high in April, Pill said that prices rising at more than four times the central bank’s 2 per cent target made for “obviously a very uncomfortable situation” and pledged to bring inflation down.
But he added that the BoE was still grappling with the difficult question of how much inflation would fall on its own, since household finances are being hit hard by the cost of living crisis.
Among the key factors determining how much interest rates would have to rise, Pill said, were whether companies felt they could raise prices without much consequence and whether people thought they could demand higher wages without a fear of losing their jobs.
“The UK labour market is tight, wages are growing at stronger rates than would normally be deemed consistent with the inflation target, and business confidence is resilient, in part in anticipation of being able to re-establish profit margins. In short, inflationary momentum in the UK is currently strong,” Pill said.
He added that this momentum behind rapid price rises was increased by Brexit reducing the supply of workers, a retreat of globalisation and lasting effects of Covid-19, which caused almost 500,000 people to leave the UK labour market.
“Avoiding any drift towards the embedding of such ‘inflationary psychology’ into the price setting process is crucial,” Pill said.
Stronger than expected retail sales figures for April may also increase pressure on the bank to raise interest rates, although details of the data indicate this may have been a one-off.
Pill predicted that further interest rate rises would be needed on top of the four already delivered. This would increase rates from the current 1 per cent level and, by discouraging spending, would help bring inflation down.
“It is the need for a continuation of this transition in monetary policy that led me to support the 25bp hike in Bank Rate at the May MPC meeting,” Pill said. “And, even after this hike, I still view that necessary transition as incomplete. Further work needs to be done.”
Allan Monks, economist at JPMorgan, said Pill’s clear concerns about inflation suggested a majority on the MPC was now “leaning towards a more hawkish interpretation” of the bank’s recent guidance. Monks added: “The risk the MPC will need to hike every meeting this year appears greater than it having to go on hold after August”.
Pill is not seen as one of the most aggressive members of the Monetary Policy Committee and voted for a quarter point interest rate increase this month, unlike three of the nine members who favoured a half point increase.
He attributed his caution to the coming “substantial squeeze in UK residents’ real incomes, which will weigh on future demand and employment”.
But while Pill said he did not want rapid interest rate rises, he was clear that there would need to be more increases to ensure that high inflation did not come to be seen as normal in the UK.
“It is that commitment that has led me to support a tightening of monetary policy since I joined the Committee last September, and to signal today that this tightening still has further to run,” he said.
In one of the latest indications of current economic conditions, Friday’s retail figures showed sales in Great Britain rising 1.4 per cent between March and April. This compared with declines the previous two months and economists’ expectations of a 0.2 per cent drop.
However, the retail data included an increase in supermarket sales of alcohol — a possible indication that the overall increase was partly due to consumers responding to rising prices by staying in rather than going out to eat and drink.