Inflation: Has the Bank of England been asleep at the wheel?

Worries are growing that the UK could be clobbered with a cost of living squeeze and a hike in interest rates after the Bank of England’s chief economist warned this week that higher inflation could prove more persistent than previously thought, writes Mattie Brignal.

Huw Pill – ex-European Central Bank, ex-Goldman and ex-Harvard – told MPs on Thursday that the “magnitude and duration of the transient inflation spike is proving greater than expected”.

Pill shares his predecessor Andy Haldane’s concerns that the Bank is too relaxed about price rises.

Even so, it’s possible the Bank still isn’t taking the threat of inflation seriously enough. Pill is sticking to the Bank’s central assessment that the trend won’t become entrenched.

But evidence that price rises will come and then go soon is mixed at best. Signs of inflation – currently running at 3.2 per cent, above the BoE’s 2 per cent target – are everywhere.

Businesses are being hit by a cocktail of inflationary pressures, including staff shortages, supply chain disruption, rocketing energy prices, and a scarcity of raw materials such as copper and aluminium. Anecdotally, those in business report rocketing prices for all manner of goods and materials. Global supply chains were disrupted by the pandemic. Now, energy shortages in China are inhibiting production. The cost of shipping has rocketed.

This is not just hitting Britain. The magazine Forbes estimates that shipping a container from southern China to the US west coast is now as high as $20,000. It used to cost $3,000.

In Britain, similar price spikes are being felt by industry first, but will trickle down to consumers who are already feeling the pinch. Data from the Office for National Statistics (ONS) found 10 per cent of firms increased their prices in early September, up from 8 per cent in mid-August. Two thirds of manufacturers are expected to raise their prices in the run-up to Christmas, according to a British Chambers of Commerce poll.

If the shortage of workers in key industries – such as HGV drivers – is resolved by bumping up wages as Boris Johnson suggested this week, this will only add further pressure.

And without an accompanying boost in productivity, wage increases don’t help. Neil Carberry, chief executive of the Recruitment and Employment Confederation, said: “While the current crises will pass, rising input costs and further tax rises would only mean higher prices and lower investment in the medium term. It is essential that government works in partnership with business to deliver sustainable growth and rising wages, rather than a crisis-driven sugar rush.”

The property market is also red-hot, for now. The Halifax house price index has risen by 7.4 per cent in the last 12 months. “The solution is obvious, and painful,” writes Neil Collins for Reaction. “Higher interest rates will help savers and bring an end to near-zero mortgage rates. They might also shake faith in the belief that house prices can only go one way, and start a much-needed bear market in domestic property.”

Central banks use higher rates to try to bring down inflation. Markets are pricing in a rate rise from 0.1 per cent to 0.25 per cent by the end of the year. But with the post-Covid recovery not yet assured, policymakers will be reluctant to say goodbye to cheap as chips borrowing. And after more than a decade of ultra-low interest rates, the impact of even a modest increase could hit hard.

The Bank’s prediction is that inflation will peak above four per cent and only fall back below its two per cent target in the second half of next year. As well as maintaining rock-bottom rates, it is also ploughing on with its £875bn stimulus programme.

But the expectation among many economists that the Consumer Prices Index could top five per cent in the spring (and the related Retail Prices Index could hit seven per cent) has helped to drive up government bond yields, which move inversely to bond prices.  

The discrepancy matters. As Ian Stewart, Deloitte’s chief economist, points out: “Were the mantle of central bank credibility to slip, higher expectations of inflation could, through price and wage setting become a self-fulfilling prophecy. If higher inflation fuels a spiral of wage pressures, they, too, could become entrenched.”

Inflationary alarm bells are ringing and the danger in the weeks ahead is that markets lose faith in the Bank’s judgment and conclude that, despite Huw Pill’s warning, the authorities moved too slowly to respond.