Andrew Bailey has signalled that financial markets have been wrong in their growing belief over the past month that the Bank of England will need to impose many more interest rate rises to bring inflation under control.
Speaking at a cost of living conference in London on Wednesday, the BoE governor said the central bank still had no presumption that it would raise interest rates further from the current 4 per cent level.
While financial markets now expect rates to rise to 4.75 per cent by the end of 2023, up from an expectation of a peak of 4.25 per cent at the start of February, Bailey said he had not seen anything in the data to justify the change in outlook.
“My reading of the evidence since our February meeting — the data we have had for economic activity, the labour market and inflation — is that the economy is evolving much as we expected it to,” said Bailey.
“Inflation has been slightly weaker, and activity and wages slightly stronger, though I would emphasise ‘slightly’ in both cases.”
The market interest rate on 10-year government bonds dipped after Bailey’s speech but did not return to the level at the close of trading on Tuesday. The government’s borrowing costs over 10 years remained at 3.87 per cent, up from 3.32 per cent a month ago.
Samuel Tombs, chief UK economist at the consultancy Pantheon Macroeconomics, said that “markets need to price in a higher chance of no-change in bank rate” following the governor’s speech.
Bailey’s caution about persistent inflationary pressures contrasts with financial markets globally, which have taken evidence of more persistent core inflation in the US and Europe alongside less evidence of a likely UK economic contraction as a signal that central banks will need to raise interest rates further.
With little news since the BoE raised interest rates by half a percentage point to 4 per cent at the start of February, Bailey warned people not to expect the bank’s core message on inflation to change.
“At this stage, I would caution against suggesting either that we are done with increasing bank rate, or that we will inevitably need to do more,” he said.
“Some further increase in bank rate may turn out to be appropriate, but nothing is decided. The incoming data will add to the overall picture of the economy and the outlook for inflation, and that will inform our policy decisions.”
Growing market expectations of a rise in interest rates over the past month have also been unwelcome news for chancellor Jeremy Hunt as he prepares for his first Budget on March 15.
Market expectations of rates feed directly into five-year forecasts of the cost of servicing government debt from the Office for Budget Responsibility, the fiscal watchdog, which are no longer much lower than the rates used in November’s Autumn Statement.
The BoE still expects the rate of inflation to fall rapidly this year even though the level of prices will stay much higher, with the decline speeding up in April when energy bills are forecast to rise a lot less than they did last year.
Bailey said the smaller rises would not relieve households of cost of living difficulties because prices themselves had not come down. As a result, he added, the BoE had to “monitor carefully” how the very sharp interest rate rise to 4 per cent over the past 15 months is “working its way through the economy to the prices faced by consumers”.
“We need to calibrate monetary policy with great care to return inflation to target sustainably,” said Bailey, although he added that if inflation appeared to be more persistent, the BoE would need to lift rates further.
“If we do too little with interest rates now, we will only have to do more later on. The experience of the 1970s taught us that important lesson.”