Bank must tame inflation now before it gets nasty
A busy couple of days for Huw Pill, the Bank of England’s chief economist. Two events in 48 hours. I’ve read through the first, a speech given last night, concerning the bank’s asset purchase programme, now being wound down, and the need to control inflation.
It’s typically dense. But it does tell us something in the wake of the Conservative Party reluctantly accepting Jeremy Hunt’s fiscal squeeze, the details of which came after the last meeting of the Bank’s rate setting Monetary Policy Committee (MPC). Mr Pill said that “further action is likely to be required” to ensure inflation will return sustainably to its 2 per cent target over the medium term.
That would be the bitter pill, for borrowers to swallow. But we knew that the Bank’s recent 0.75 percentage point hike to 3 percentage points wasn’t going to be the last rise, even if a pair of the rate setting MPC’s members argued for a lesser increase.
On the other hand, Mr Pill also reiterated his view that the markets’ forecasts have been too high. “I do not anticipate the levels of Bank Rate priced in financial markets when the forecast’s conditioning assumptions were frozen will be required,” he said.
To explain: they had been pricing in base rates as peaking at 5.25 per cent when said forecasts were compiled. Pill expects the peak to be somewhat lower than that. He also said that the Bank will continue to sell its portfolio of bonds, purchased as a means of easing monetary policy when interest rates hit the floor.
The fact is that Mr Hunt’s fiscal plan will inevitably take demand out of the economy, easing some of the inflationary pressures, helping the MPC. Fiscal policy is now working hand-in-hand
with monetary policy, which is sensible (if painful). So there won’t be the need for the shock therapy the markets feared (and priced in). Call it the “dullness dividend” in action now that Liz Truss and Kwasi Kwarteng are gone and the supposed “grown ups” are in charge.
It’s notable that mortgage rates have fallen below the 6 per cent level they hit after Kwarteng’s disastrous mini-Budget, with its list of unfunded tax cuts. All this helps the housing market. It is still going to fall, and perhaps quite sharply, but things look a lot less nasty than they did. Mortgage rates are still unpleasant. But they’re no longer hellish. Mr Pill’s speech suggests that they will remain in that territory.
A note of caution, however. This all depends on the “second order” inflationary effects that the Bank needs to contain – although it can’t do anything about the energy prices that put rocket fuel into the inflation rate. There are still people who feel that it is taking things a mite too easily given what the inflation figures have been telling us. Borrowers won’t thank me for saying it, but I think the MPC might have a point.
Inflation, once it becomes entrenched, can prove devilishly hard to get shot of. It has already shattered the Bank’s hopes that it would prove “transitory” and it could easily do so again. Sorry to end on a down note. I realise that I’m at risk of sounding like a Jeremiah again. But the point needs making. We’d better hope Mr Pill is right because it could still get quite nasty if he isn’t.
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