A nervous public can take comfort from bank’s divided policymakers


18th November 2021

Policymakers on the Bank of England’s Monetary Policy Committee – the group tasked with setting UK interest rates – are increasingly divided. To my mind, that is a good thing. For those who see groupthink as a good predictor of a failing organisation, this is encouraging from the Bank. After the deepest economic contraction in three hundred years – and with a very rapid recovery now underway – any group that opines too uniformly that they know the path for the UK economy should be treated with scepticism.

However, the nine-strong Committee can’t avoid revealing their personal views. It is part of their job description. Tasked with making these difficult judgements, they have begun to set out their stalls ahead of next month’s policy decision. Three members have spoken in recent days – Dave Ramsden, Michael Saunders and Jonathan Haskel – and have all put different emphases on the strength of the UK economic recovery and the enduring impact of the COVID-19 pandemic on inflation. It is likely that the remaining six will also possess a wide range of views. So, what are their key judgements, and why does this matter?

It is important to acknowledge that there are few modern precedents to the economic disruption experienced over the last sixteen months. Commodity prices, shipping costs and asset prices were eye-catching on their way down – with the oil price briefly turning negative last year – and have attracted even more attention as they have rebounded strongly. Whether these price increases will continue as the global economy adjusts to living with COVID-19 is far less clear.

For example, one of the big inflation stories in 2021 has surrounded the price of North American wood. This price skyrocketed 400% in just over a year following the start of the pandemic. However, since early May, wood prices have almost entirely reversed. Even the most experienced commodity traders have been shocked by these price swings. In the UK there are anecdotes aplenty about the shortage of workers in the hospitality sector. These have been supplemented by stories of big financial incentives to attract and retain workers in pubs and restaurants. But data released this week by the Office for National Statistics show that average wages in the hospitality sector have in fact risen slower than the wider economy in recent months. Together these two case studies help illustrate the huge interpretive challenge the pandemic has thrown up.

My own view is that most of these big price effects will prove temporary. I expect that the power currently gifted to some suppliers and workers to demand price and wage increases will quickly dissipate. But there are compelling counterarguments made by some excellent economists. I would be doing readers a disservice to dismiss their fears.

Which viewpoint eventually triumphs will, in large part, hinge on whether the UK public – on seeing these very visible price increases – will adjust their expectations for higher future inflation. The latest forward-looking signals available from financial markets and consumer surveys suggest this is not happening. The interest rates that investors are demanding to hold government and corporate debt remain exceptionally low – and have been falling further in recent days. This would appear rather irrational should investors expect the value of interest payments to be eroded by sustained high inflation. And it is not just these financial market signals. The Bank of England commissions a closely watched survey of inflation expectations amongst the UK public. In its latest survey the public responded that they expect inflation of 2.4% over the next twelve months, and 1.9% for the twelve months after that. Both these measures were lower than those recorded the previous quarter. The UK public is respectfully declining to worry about high inflation – for now at least. Set against these latest data points is the fact that expectations can shift very quickly. Perhaps more so now in an increasingly interconnected world where the dissipation of price information is very efficient. The argument goes that by the time this expectations data begins to shift it will be too late to take effective countermeasures.

The other aspect to inflation is the degree to which the global forces that have held down price growth in recent years are going to reassert themselves as the pandemic eases. In mainland Europe and large parts of Asia there is ample spare capacity to respond to higher prices in economies like the US and the UK. This “global supply glut” has been disrupted by the pandemic. But with the volume of tradeable goods and services likely given a boost by the pandemic – as many consumers and businesses have familiarised themselves with consuming goods and services remotely – that is unlikely to last.

But why does this debate matter? Had I been writing this column two decades ago few Times readers would have needed reminding of the costs of high inflation. But memories have faded – or simply don’t exist for many younger readers. This stems from the official rate of UK inflation averaging just two percent over the last twenty years. But high inflation, should it return, will impose costs to those on fixed incomes such as Universal Credit or occupational pensions. That disruption will extend to businesses needing to renegotiate contracts more regularly, and for the cost of funding long-term investments such as those needed to transition the UK economy to net zero.

So overall I interpret the post-pandemic UK economy as in the throes of an inflationary episode, rather than at the start of a new inflationary era. This does not mean that a pre-emptive move by the Bank of England to end the purchase of government debt – known as Quantitative Easing – isn’t prudent. I believe it would be. This would make little impact on the exceptionally low interest rates facing borrowers. But it would send an important signal that the Central Bank is prepared to act decisively should inflation prove persistent.

So, there is much for the MPC to mull over in the weeks and months ahead. UK businesses, households and some senior figures in the Treasury are watching on nervously. They can take comfort that with professional opinion divided, policy is likely to change very gradually. Whatever is decided next month the challenge for the Governor, Andrew Bailey, is to translate the views of a divided Committee into a clear and confident message.

Simon French

Managing Director, Head of Research

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