Bailey Says BOE Must Sharpen Response to Big Economic Shocks

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(Bloomberg) — Bank of England officials made their clearest admission yet that they were slow to respond to a jump in inflation and have lots to learn about how they handle the sorts of large shocks buffeting the global economy.

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BOE Governor Andrew Bailey acknowledged that inflation had already been on the rise before Russia’s invasion of Ukraine and that policymakers had underestimated the persistence of upward forces on wages and prices.

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“The shocks that we’ve faced have been unprecedented,” Bailey said Tuesday in Parliament. “I think there are big lessons about how do we operate policy in that world and in a world of very substantial uncertainty.”

The remarks in response to lawmakers on the Treasury Committee underscore rising political concern about the impact the cost-of-living crunch is having on consumers after seven months of double-digit inflation driven by food and energy prices.

Bailey said the BOE’s Monetary Policy Committee had held off on responding to inflation during the pandemic because it was worried about the possibility of a surge in unemployment as the government wound down its jobs-supporting furlough program.

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“We hold our hand up and say that’s a judgment we had to make and it didn’t turn out right,” Bailey told MPs.

Now, he added, the bank is concerned about the persistence of inflation. The Consumer Prices Index was 10.1% in March — more than five times the BOE target.

Economists are expecting inflation to slip to 8.2% when the next batch of data is released Wednesday, due to a sharp rise in energy prices a year ago falling out of the comparison.

“All inflation hurts, and hurts the least well off hardest,” Bailey said. “This inflation is particularly hard because it’s concentrated in energy, food and housing costs. And we’re very, very aware of that. But if we don’t get it back to target and don’t get it under control, it gets worse.”

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He said this was “a hard message right now, it’s a very hard message. I don’t like giving it because I don’t like the fact that there are people who are experiencing real suffering.”

Even so, the BOE is worried about surging food prices and other elements in the consumer prices basket that may keep inflation elevated. He vowed to do what it takes to return inflation to the 2% target.

“We think there are there are risks of persistence,” Bailey said. “We are focused very much on what we need to do, to guard against what we see as these risks.”

While rising interest rates are adding to cost-of-living pressures for mortgage holders and other borrowers, Catherine Mann, an external member of the MPC and its most hawkish member, said she did not yet think financial conditions were tight.

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“Tightening and tight are not the same,” she told the cross-party panel. “In particular real rates are still below zero. So from that standpoint, we can’t make judgments about peak and path of Bank Rate because it’s data dependent.”

Delayed Impact

She noted that a large proportion of the rise in Bank Rate had not yet fed through to the economy — mainly because of the high proportion of people on fixed-rate mortgages, who will not feel the effect of higher rates until their current deal comes to an end. 

BOE Chief Economist Huw Pill said there were questions over whether policymakers’ modeling needed to change given the unexpected persistence of inflation in the aftermath of a series of shocks, from Covid to the energy-price crisis.

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Bailey said officials now think economic forecasting models are “too symmetric,” as they have predicted that inflation would fall at broadly the same rate that it rose. This has not been the case.

Mann, however, said there would always be limitations to forecasting.

“I have tended to vote for higher bank rate changes at most of the meetings last year,” she said. “That’s because in my view, we were underestimating the degree of persistence, the persistence of persistence. In our judgment, the model was never telling us about persistence, primarily because it was estimated on historical data. It is linear and therefore cannot address some of these behavioral changes that we observe at a micro level.”

Bailey denied that the BOE damaged confidence late last year by predicting a long recession, a forecast that was subsequently revised away. Since then, business and consumer sentiment had both improved due to a fall in energy prices, he noted. “I think that’s probably affecting confidence more than our forecasts.”

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Asked whether companies were adding to inflation by bumping up their prices by more than necessary, Bailey said the Bank’s network of agents who speak to businesses around the country were not yet picking up on signs of so-called “greedflation.”

“Our agents do pick up, I should say, a story about margins,” Bailey said, adding that it was “about rebuilding margins that were squeezed” rather than profiteering.

He said the Bank did not yet have any sense that the wave of labor strikes that has gripped the UK since last year were adding to inflation by reducing supply, but said “they do introduce some volatility.”

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(Includes more comments from the Treasury Committee hearing)