THE BANK OF ENGLAND’S PERSISTENT INFLATION PROBLEM

The Bank of England’s Monetary Policy Committee must be feeling rather like the worst-performing pupil in school right now. Its peers seem to have a better handle on inflation. Although the US Federal Reserve and European Central Bank both struck a hawkish tone this week, the end of their historic interest rate raising cycle is within sight. It will be harder for the MPC to convince markets that that is the case for the UK at its meeting next week. Headline inflation is a lot lower in the US and eurozone compared with the UK. The OECD expects UK price growth this year to be one of the highest among major economies. A recent run of higher-than-expected inflation and wage growth figures also suggests the BoE will have much more work to do. The persistence of Britain’s inflation is an increasing concern. Annual core inflation — which measures underlying price pressures — has eased recently in America and Europe to just above 5 per cent in May. Though the UK is yet to release data for last month, in April core price growth rose sharply to 6.8 per cent, from 6.2 per cent in March. Wage growth, which buoys inflation, is showing resistance. The annual increase in advertised wage data collected by Indeed, an employment site, has flattened out or declined across the EU and US after peaking in 2022. But it has continued to rise and hit new records in the UK. This means a wage-price spiral — when high inflation drives iterative demands for higher pay packets — remains a higher risk in the UK than in the US and the eurozone. The BoE does have some extenuating circumstances. The UK has experienced the worst of both worlds: a big energy shock similar to the eurozone, as well as labour shortages like those in the US. A fall in European natural gas prices since last year’s highs has driven down energy inflation more rapidly in some eurozone countries. This in part reflects differences in how consumer energy prices are set; further falls will increasingly filter through in the UK. Britain’s hot jobs market has meanwhile been exacerbated by idiosyncratic factors including high levels of long-term sickness, early retirement and changes to its immigration rules. Post-Brexit trade barriers may also have added to soaring food price inflation, according to a study by the London School of Economics. Nonetheless, the central bank has misjudged the persistence of inflation and extent of labour shortages. And wide-of-the-mark forecasts erode faith in the BoE’s command of price stability. After further data shocks this week, financial markets were expecting interest rates to reach 5.75 per cent by the end of the year — up from 4.5 per cent currently. Whether rates will need to go that high is unclear, but the impact on those seeking mortgages or coming off fixed rates is severe since rate expectations factor into the pricing of loans. Banks have been pulling mortgage products and pushing borrowing costs higher. The BoE’s governor, Andrew Bailey, appeared in front of a House of Lords committee on Tuesday as part of an inquiry into the central bank’s performance, much like a student being hauled into the headmaster’s office. The bank later announced a review into its forecasting errors in a welcome sign that it will attempt to learn from its mistakes. At next week’s meeting, a 25 basis point increase makes sense. A 50bp rise, as some are pushing for, may be too much of a shock for markets. But the central bank’s communications will be just as important as the rate rise. It will need to convince the public that it understands its recent errors, to help maintain its influence over rate expectations. The bank may also wish to reassert more forceful language on its determination to bring inflation back down to 2 per cent. It needs to get a grip quickly.