Rising UK costs put authorities and central financial institution on collision course

Sunak reiterated his “complete support” for the under-fire Bank of England Governor Andrew Bailey.


LONDON — In January, British Prime Minister Rishi Sunak pledged to halve inflation by the end of the year ahead of the critical general election in 2024.

At that time, headline consumer price inflation was 10.1% annually. Given that most economists assumed that figure would naturally halve as the shock from rising energy prices wore off, the pledge seemed an open target for Sunak’s conservative government.

Still, May’s headline CPI came in at 8.7%, flat from the previous month, while core inflation – which excludes volatile energy, food, alcohol and tobacco prices – rose to 7.1%, the highest since March 31 years.

Annual average non-bonus wage growth also accelerated to 7.2% in the February-April quarter from 6.7%, the fastest rate on record, while the labor market continues to be hotter-than-expected and the UK posts a unique rise in wages Has experienced long-term illnesses This has boosted the labor force participation rate.

Meanwhile, economic growth nearly stagnated and the national debt exceeded 100% of gross domestic product for the first time since March 1961.

The Bank of England increased the pace of rate hikes again in June, raising interest rates by 50 basis points to 5%, further fueling domestic fears of a mortgage crisis and setting itself apart from other major central banks, which have either slowed or paused rate hikes.

Shaan Raithatha, chief economist at Vanguard, told CNBC’s Squawk Box Europe on Monday that Britain was suffering “the worst of both worlds”.

“We had a US-style labor market shock, particularly the large number of long-term illnesses that severely impacted the labor supply there, and there was also a European-style energy shock triggered by the war in Ukraine.” he said .

“What is perhaps surprising is that the energy shock in the UK was larger than in most parts of mainland Europe.”

Raithatha suggested that this may be partly because government policymakers were too slow to react in the early stages of the energy crisis and, when they did step in, capped energy prices to higher levels than many others.

“There is a problem here because the economy is very resilient. We know that the transfer to mortgages is a bit slower and a bit less effective than in the past and so the bank clearly needs to do a little more to get inflation under control,” he added.

Problem “mainly made in Moscow”

After recent inflationary pressures, Sunak reiterated his “complete support” for the Bank of England and under-fire Governor Andrew Bailey.

In his January speech, the Prime Minister said the promise to halve inflation was his personal responsibility. However, should UK CPI remain stubbornly high into year-end, many expect the Bank of England to be back in the crosshairs of ministers who accuse it of seeking a rebalance.

“Economic and political cycles also appear to be mismatching for the government, especially as this is the time it’s becoming increasingly difficult to commit to tax cuts ahead of the 2024 election as public debt has exceeded GDP for the first time since March 1961.” , he told Richard Flax, chief investment officer at Moneyfarm.

“For the Chancellor to reiterate his pledge to halve inflation this year while pledging to boost the economy and reduce debt seems a big commitment given the challenges the UK is facing.”

After last month’s high inflation, Panmure Gordon chief economist Simon French said Britain’s problems were “mainly Moscow-made, but not entirely Moscow-made”, adding that there was a “Brexit element” at play.

“Since the Brexit transition, working-age inactivity has increased by 4.5%, while all other G7 countries, perhaps with the exception of the US, have seen a decline in inactivity. So we appear to be an outlier when it comes to disruptions on the supply side of the economy, which is driving core inflation higher,” French said.

“But Mr Sunak has a fair narrative here too, which relates to global factors. The UK is disproportionately affected by the price of gas because it accounts for a large part of heating bills, but also by the fluctuating supply of electricity, and that’s what drove the CPI component – headline – up 120% compared to around 40 % in mainland Europe.”

In a recent CNBC-moderated panel at a monetary policy forum in Sintra, Portugal, Bailey noted that the UK workforce is unique and remains below its pre-Corona levels.

“I see that when I travel around the country and speak to companies. They tell me very often that they plan to keep as much of the workforce as possible, even in the event of a downturn, because they were worried and.” “It was difficult to recruit workers,” he said.

However, Bailey denied that Brexit was the key factor behind labor market tightness and ongoing inflationary pressures, instead citing the country’s response to the Covid pandemic.

The bank expects Brexit to drop productivity levels in the UK by just over 3% over the long term, while Monetary Policy Committee member Catherine Mann recently told a parliamentary committee that extra paperwork is hurting small businesses and the Inflation has increased pressures.

“It’s not just small firms in the UK who want to export, it’s also small firms in Europe who acted as subcontractors and created competition in the UK market, so there is an inflationary effect through the competition channel,” she added .

Bank of England ‘Impotence’ and the ‘British Disease’

UK inflation is still expected to fall sharply for the remainder of the year as the energy price ceiling is cut by 20% from 1 July and existing interest rate hikes weigh on the economy, depressing demand and employment.

The Bank of England has maintained its data-driven, meeting-by-meeting approach to tightening monetary policy, and members of the Monetary Policy Committee have openly questioned market prices for a top rate of just over 6% through winter 2023 and into next year.

A major concern for economists is central bank credibility, and Bailey recently issued a mea culpa for the MPC’s erratic inflation forecasts for the past 18 months.

Panmure Gordon’s French suggested that if the Bank of England had “clear credibility” policymakers could say it would take 18 months to two years for the blunt instrument of interest rates to get through in the economy, affecting markets’ confidence and kept by the public. However, recent announcements have had no effect.

“The UK as an economy – 3% of global GDP, less than the population – is largely a price taker in terms of monetary conditions and whether Andrew Bailey or his predecessors are willing to admit that, there is a degree of impotence regarding the extent to which domestic monetary conditions can affect the domestic economic picture,” he said.

French compared the current economic situation to the “British Disease” period of economic stagnation and high inflation in the 1970s, also pointing out that the UK reached double-digit inflation in the 1990s and was subsequently the only developed country , whose inflation was well above the target of the global financial crisis.

Thanos Papasavvas, founder of ABP Invest, also pointed to the UK’s unique vulnerability to high inflation, but said the Bank of England should have realized this much earlier.

“I blame a lot of what happened on the comments he made a couple of years ago, when he downplayed and smiled about inflation and the risk of inflation, at a time when inflationary pressures were rising “a country that tends to be inflationary,” he told CNBC.

“You don’t do that in the UK. Just a few months ago, expectations that inflation would drop to 2% or 3% were very unrealistic, so I think they have been very poor at communicating and have a very difficult decision.”

The Bank of England is conducting a review of its inflation forecasting mechanisms, and Bailey recently told a parliamentary committee that the central bank must “learn lessons” from the process, although it still expects inflation to fall quickly this year, albeit at a slower pace Rate.

Ahead of the coronavirus pandemic and Brexit in 2020, French stressed that the Bank of England has averaged 2% inflation for 22 years, but that it underestimated the supply side effects of Brexit.

He pointed out that there will be “further tensions” over food inflation and secondary effects as more controls on EU livestock and crop imports are introduced later this year.

“If you look at some of the mistakes it has made, some of it was unpredictable as far as the futures and energy markets are concerned, some of it was just plain unpredictable when they were trying to stem the growth in the supply of imported labor in the UK understand,” French said.

Comments are closed.