Bailey highlights BoE concerns about post-pandemic inflationary risk

Andrew Bailey has signalled renewed concern about the possibility of rising inflation as the UK recovers from the coronavirus crisis, saying that the risks are now “increasingly two-sided”.

Speaking at a Resolution Foundation event, the Bank of England governor said the central bank was not about to raise the interest rate in response to a rapid recovery and would need to see “clear evidence” that inflation would be sustainable at the 2 per cent target before it moved.

But he highlighted that the BoE was undertaking work both on the preparations for negative interest rates if the recovery disappointed and on how best to tighten policy if rapid spending growth rose inflationary pressures.

“These decisions are detached from our current or likely policy decisions, but do recognise the increasingly two-sided nature of the risks we face,” Bailey said.

In the past month, financial market expectations of future inflation and interest rates have risen sharply following a vaccine-fuelled improvement in the economic outlook.

Government borrowing costs were largely unmoved after Bailey’s speech, rising 0.01 percentage points to 0.77 per cent for 10-year debt. These interest rates have risen more than 50 per cent over the past month as investors expect a more rapid recovery and begin to worry about inflation eroding the value of their investments.

Markets no longer expect the BoE to set negative interest rates later this year to stimulate the economy and instead forecast that the central bank will start raising interest rates in 2022.

Bailey validated some of these expectations, saying that the next BoE forecasts were likely to be stronger than the last because it would take account of the additional stimulus the government added in the Budget last week. This would help to keep the peak of unemployment lower than the 7.75 per cent the BoE previously forecast.

“Our last forecast was pre-Budget,” Bailey said, adding that in the next forecast in May, “we will have a lower profile of unemployment in the near term and probably lower throughout [the forecast]”.

Even with a stronger recovery, Bailey said this would not necessarily lead to inflation because the longer-term outlook for prices depended on the balance between demand and supply. Both were highly uncertain, he said.

In the short term, the BoE’s focus was on raising the inflation rate, Bailey added. “Viewed from where we are today, our task is to get inflation up towards the [2 per cent] target.”

Inflation would soon rise from the current 0.7 per cent rate in January, Bailey said, because the fuel price cuts a year ago would soon fall out of the 12-month comparison, but the BoE would take some time before it decided whether the rise in inflation was more persistent and would require action.

The BoE is analysing whether it is best to raise interest rates to cool the economy or sell some of the £895bn assets it has bought since 2009 in its quantitative easing scheme.

“We will need more evidence than we usually do that we are seeing a sustainable rise in inflation”, Bailey said.

But he stressed that the BoE’s views were not set in stone because what mattered was the degree to which household and corporate spending surged as Covid-19 restrictions were lifted and the ability of companies to supply to the market post-pandemic without raising prices.

The economy requires “a dual recovery of demand and supply, so obviously you can get quite a lot of different paths for the recovery . . . so it’s not unreasonable to think there’s quite a range of possible outcomes,” Bailey said.