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The Bank of England’s chief economist said on Wednesday that key drivers of UK inflation were showing “uncomfortable strength”, underscoring the continued uncertainty over the outlook for interest rates.
Huw Pill said the central bank had made “substantial progress” in its efforts to bring down inflation, which finally hit the official target of 2 per cent in May’ He added it was a question of when, rather than if, the BoE Monetary Policy Committee decided to reduce rates.
But he pointed out in a speech that annual rates of services inflation and wage growth were still running at close to 6 per cent. Recent indicators have hinted towards “some upside risk to my assessment of inflation persistence”, said Pill.
“It is hard to dispute the case that inflation persistence in the UK continues to prove — well — persistent,” said Pill. “The MPC needs to ensure that the degree of cumulative restriction in the monetary policy stance is sufficient to ensure that the persistent dynamic in recent inflation indicators is squeezed out of the system.”
Pill’s comments prompted traders to scale back their expectations for interest rate cuts this year, with traders now placing a 50 per cent chance of a rate cut in August, down from two-thirds earlier on Wednesday.
The pound strengthened on the prospect of slower rate cuts, up 0.4 per cent on the day at $1.2841.
“The market was expecting that he would go much more strongly in favour of a rate cut but he remained at best uncommitted,” said Peter Schaffrik, chief European strategist at RBC Capital Markets.
Pill was speaking as the BoE prepares for its next interest rate decision on August 1, when many economists think it may pull the trigger on a cut from the current 5.25 per cent. His words suggest that the timing of an initial move remains an open question.
The BoE has held rates at a current 16-year high since August last year, voting 7 to 2 at its last meeting to keep it unchanged. But minutes of the meeting suggested some members were becoming more comfortable with the idea of easing policy.
Pill said on Wednesday that the latest data remained consistent with the view that inflationary pressures “have now been contained, and may be starting to revert towards levels that are more consistent with the achievement of the inflation target”.
But he also said the MPC needed to be clearer on why some inflation drivers were proving to be stubborn. One explanation was that the lingering effects of the upward shocks to inflation driven by the pandemic and the Russian invasion of Ukraine were taking longer than expected to wear off.
On the other hand, the persistence of strong price growth could be a reflection of more “permanent” changes to price, wage and margin-setting behaviour in the economy. In that scenario, said Pill, the MPC would be left with “no choice” but to maintain a restrictive monetary policy.
Pill reiterated the bank’s broader guidance that interest rates would eventually need to be lowered, however. “In the absence of any big new shocks, the ‘when-rather-than-if’ characterisation of prospective bank rate cuts still seems appropriate,” he said.
Additional reporting by Mary McDougall in London
