We must get inflation down to aid economy
The UK economy is going through a very challenging period. As a consequence of the Covid pandemic and then Russia’s illegal invasion of Ukraine, we have seen large increases in energy and food prices, a substantial decline in national income and very elevated inflation. That has all hit households and businesses hard.
I, and my colleagues on the Monetary Policy Committee (MPC), hear this and a lot more, in our frequent conversations with people on our visits around the UK. On Friday I was in Edinburgh with our agent, Will Dowson, meeting with a variety of businesses from the creative, retail, housebuilding and telecoms sectors. The texture of these conversations is critical to understanding how business on the ground are reacting as we try to steer the economy to the Bank of England’s inflation target.
Things look better than a few months ago. Since October last year, inflation has fallen from 11.1 per cent to 8.7 per cent, and we expect it to be around 5 per cent by the end of this year.
But inflation remains much too high. On the MPC we remain committed to bringing it back to our 2 per cent target, and that is what we will do. Our tool for doing this is interest rates.
We are often asked how increasing interest rates helps when the cause of inflation is energy and food, which are essential goods whose prices are largely determined globally. The aim of higher interest rates is not to affect the prices of these goods directly. Instead, it is to ensure the resulting inflation does not become embedded in the economy. That is why, since December 2021, we have increased interest rates from 0.1 per cent to 4.5 per cent.
That means higher borrowing costs at the same time as the prices of essentials are rising quickly. We understand that will be difficult for some people and it’s an important consideration in our decisions. But persistently high inflation has wider economic costs as well. So as policymakers, we are required to make difficult judgements on the appropriate response.
What does all that mean for interest rates from here? We are monitoring indicators of inflation momentum and persistence closely. My own view is that it’s important we continue to lean against the risks of inflation momentum, and therefore that further increases in interest rates cannot be ruled out. As difficult as our current circumstances are, embedded inflation would be worse.