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BoE: further rate increase is necessary to rein in inflation

Author: ICAEW Insights

Published: 21 Jun 2022

The Bank of England’s chief economist warns inflation will be no quick fix and to expect further interest rate increases to achieve its objective of getting inflation back to 2%.

Huw Pill, Chief Economist and Executive Director for Monetary Analysis at the Bank of England (BoE) has said Threadneedle Street will do everything in its power necessary to get inflation back to its 2% target.

Addressing ICAEW’s fourth virtual Economic Summit this week, Pill warned that the inflationary tiger is well and truly uncaged and with monthly GDP starting to fall at an accelerating rate, the risk of stagflation was worryingly high.

Consumer confidence is at a record low and with recent salary rises unable to protect real incomes, the worry is that business confidence will follow suit, as suggested by ICAEW’s Business Confidence Monitor for Q2.

Pill said achieving 2% inflation will require “further tightening of monetary policy over the coming months”. While the Bank of England takes into account real dynamics including consumer confidence and wage volatility on the transition to achieving the 2% target, it is not the primary focus.

When will this tightening take place?

Pill reiterated that action taken will only take place over the medium term. “This reflects the fact that we can’t have an immediate impact on inflation, so we’re focused on returning to inflation to target at a two- to three-year horizon”.

In deciding what measures to put in place, the BoE is looking for any suggestion that inflation dilemmas are becoming more persistent, because they’re embedded in domestic wage cost and pricing goods and services behaviour.

“If we see evidence or more evidence of that persistence growing, then we are ready to act and maybe act more aggressively going forward than we have done thus far,” Pill added.

Will the UK’s inflation problem last longer than other countries?

Speaking at the event, Iain Wright, ICAEW’s Managing Director, Reputation and Influence, pointed out that one aspect often overlooked in inflationary pressures is the role of sterling, following recent falls in the value of the pound against the dollar and the euro.

“We import most of our energy, we import most of our food and physical goods, and that’s a really key driver of inflation,” said Wright. “Doesn’t this mean that because of the weakness of our currency, our inflation will stay higher for longer than for most of our competitors, and therefore we’re prolonging the pain?”

Pill conceded that monetary policy is not a panacea. “It is not an instrument that allows you to achieve lots of lots of different things in the short term, such as stabilising the exchange rate or fine-tuning developments in employment or activity. Monetary policy is a blunt instrument.”

The remit given to the BoE by the Chancellor tells them to use that “blunt tool” to stabilise inflation at the 2% target in a way that’s manageable. Which in Pill’s view is the right purpose.

Pill continued: “Thinking we can use that very blunt tool to do many things such as stabilise the exchange rate in the short term and ensure that any weakness in output is going to be weighed against, can distract us from the task we’ve be given and end up meaning that we are much less effective in achieving that task.

“That’s why I emphasise not to expect too much from monetary policy, but expect monetary policy to deliver what it is asked to do and what it can do.”

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