The sick man of Europe needs stronger medicine

Britain’s economic crisis demands tough decisions to be made by its central bankers and politicians

We can only hope that, one day soon, Andrew Bailey will wake up and realise he is the Governor of the Bank of England. Yet based on his most recent remarks at the European Central Bank conference in Portugal this week, it’s still not clear Bailey is aware of the critical role he plays in shaping UK monetary policy.

“The key thing for us is to bring inflation back down to target,” he announced to a room full of bankers. Yes, this is quite the “key”. In fact, we’ve been desperate for the Bank to tackle inflation for many months now, so it’s refreshing to know this is an acknowledged priority. “That is what we will do,” Bailey pronounced in his follow up. Again, good news. How? When? Is there any plan of action, apart from the Bank’s governor talking about the UK economy as if the role he plays is a minor one, at best?

If there’s any generous reading to be done of Bailey’s remarks, it was the not-so-subtle indication that the Bank is considering a 50 basis points jump in interest rates, signalling to markets that faster action may succeed the rather conservative 25 basis points rises we’ve now experienced five times in a row. Of course, Bailey can’t say directly how quickly interest rates will rise in the future – not least because he can’t assume how the other eight members of his Monetary Policy Committee will vote – but with the Federal Reserve taking bullish action on rates, the pressure is on for the Bank to follow.

But in many ways, it’s too little too late. Central bankers were still in denial about inflation when the headline rate was already double the Bank’s 2pc target. There was no move on interest rates when hiking them could have made a meaningful difference to curbing price spirals – and given the Bank more international credibility to handle the current situation.

Market expectation is now for rates to reach 3pc: a substantial rise from where we were last winter, when rates were still hovering at record lows. But while this would still be a historically low rate, such a rise will come as a serious shock to generations of borrowers who aren’t used to accounting for interest rate hikes. As one MP puts it to me: “This is going to be a disaster. We are about to experience sky-high inflation alongside higher borrowing costs, but not high enough that it makes a serious difference to prices.” In other words, the failure of the Bank to act for so long means that interest rate hikes now risk increasing financial pain without the benefit of tackling higher prices.

All this contributes to the growing risk that the UK could soon become the sick man of Europe. Bailey hinted at this in his comments too. “I think the UK economy is probably weakening rather earlier and somewhat more than others,” he said – again, more like a passive commentator than an active participant.

The problem is twofold. Like the rest of Europe, Britain is experiencing a serious shock to its energy sector, as Putin’s war has sent oil and gas prices spiralling. And like America, Britain is suffering from an extremely tight labour market, which is also driving prices up, as the official unemployment rate sits at historical lows and the job vacancy rate at a record high of 1.3m. It is the latest example of a long-standing problem: the UK having European levels of taxation and American-quality public services.

As a result, Britain is on track for inflation to peak in the double digits, with current forecasts estimating 11pc. Inflation in America is still below UK levels. The EU average also currently sits behind the UK, at 8.8pc.

The picture of the sick man is, of course, complex: the most recent projections show Britain’s economy growing more than the Euro-17 this year. Both France and America have reported contractions to their economies already, in the first quarter of the year, while Britain’s economy was confirmed yesterday to have grown by 0.8pc.

But with inflation so extreme in the UK, this (rather lacklustre) growth is cancelled out in practical terms. Real household income was down by 0.2pc between January and March, falling for the fifth consecutive quarter: so while the British are being told that their economy is growing, they feel in their pockets and pay packets that their purchasing power is shrinking.

And it’s going to get worse, according to Bailey, as we experience a “further step-up in UK inflation later this year” when the energy price cap rises once more – by some current estimates, by at least £1,000. So the better growth the UK is experiencing now compared with its neighbours is still at risk of taking a downward turn.

If that happens, central bankers, and indeed politicians, still seem underprepared for difficult times. It’s been well-established that they can print and spend money, but the more difficult decisions remain off-limits. To tackle the tight labour market, this should include considering visa extensions and discussions around how to get Britain’s 5m missing workers back into the workforce. To tackle rising energy costs, politicians need to seriously consider what they can trim back and cut to let people keep more of their earnings.

And the Bank needs to stop dithering and acting like a neutral factor in the economic crisis we’re in. That starts with its governor.