Bank of England’s credibility is crumbling
When it comes to inflation, central banks are badly behind the curve
“Did you ever think you’d be paying this much for a gallon of gas?” declared Joe Biden last Wednesday. “In some parts of California, it’s $4.50 a gallon!”
The average price of a gallon of petrol in California was $3.76 as recently as May. Last week, according to the American Automobile Association, that average hit $4.64 across the Sunshine State – even more than Biden’s estimate.
California has seen a 24pc rise in fuel costs in just six months. Despite that increase, the price of litre of petrol in Britain – which just topped a record £1.46p per litre – is still half as much again as in the States.
Biden was speaking in the aftermath of some pretty shocking US inflation data. In October, the US Consumer Price Index was 6.2pc up on the same month last year – far higher than financial markets expected.
Inflation in the world’s biggest economy is now at a 30-year high. And even if you take the “core” measure, which excludes volatile items like food and energy, US inflation was still 4.6pc last month – again, much higher than expected.
It’s not just the US, of course. Eurozone inflation surged to 4.1pc in October – significantly above market expectations. And the latest UK data shows CPI inflation of 3.1pc in September, well above the Bank of England’s 2pc target.
Just weeks ago, the Bank maintained price pressures were “transitory”. The Office for Budget Responsibility has since forecast inflation looks set to average 4.5pc next year. Even the Bank of England now accepts we could see CPI price growth peak above 5pc – with many private forecasts much higher than that.
Across the world, global demand is rebooting but “the supply side” has yet to catch up. Spiralling oil prices and labour shortages are combining with pandemic-related logistical snarl-ups, sending business costs soaring.
Producer prices in China are now rising at their fastest pace in more than a quarter of a century. Chinese “factory gate” inflation – reflecting prices at which wholesalers buy materials from producers – hit 13.5pc in October, up from 10.5pc the month before.
Businesses of all kinds – from manufacturers to service providers, from West to East – are enduring much higher bills for labour, energy, raw materials and logistics. Slowly but surely, such rising input costs are being passed on, developing into political-explosive headline cost-of-living rises.
Earlier this month, the Bank of England held interest rates at the ultra-low emergency level of 0.1pc. With inflation well above target, this was widely viewed as a surprise. The money markets were betting the Monetary Policy Committee would bear down on price pressures, by raising rates to 0.25 per cent.
Yet, despite weeks in which market expectations of a rise were stoked by comments and speeches from MPC policymakers, the committee voted by 7-2 to keep rates on hold. Members also voted 6-3 to continue the Bank’s bond purchases under its quantitative easing programme. So, despite upward inflationary pressures, the virtual money-printing goes on.
Reflecting this surprise, the pound plunged against the dollar – a trend which extended into last week. Traders had expected higher rates, and therefore higher returns on money held in sterling. When that didn’t happen, they sold billions and billions of pounds.
When a central bank signals a rate rise, a rising currency tends to make imports cheaper, helping keep a lid on inflation. This is particularly true in the UK, given the public’s voracious import demand. But signalling a rate rise, without then delivering one, is a dangerous business.
Whether you think rates should go up or not – and I’ve been arguing for higher rates literally for years – leading central banks stand or fall on their credibility. Lose that and markets rebel, ignoring future signals, lurching through peaks and troughs, causing financial chaos.
Just weeks ago, Governor Andrew Bailey was arguing the Bank of England “had to act to tackle inflation” – words building on speeches and remarks from other MPC members. The money markets clearly moved to prepare. As such, Bailey spread confusion and dented the confidence of financial markets.
Given the extent of the UK Government’s borrowing, and the broader fragility of our stock and bond markets, bloated after years of QE, this is by no means an insignificant issue.
The UK economy is still expanding, but the pace of recovery is slowing. Our GDP between June and September was just 1.3 per cent higher than during the same period in 2020, we learnt last week. The same figure between April and June was 5.5 per cent – so growth has fallen considerably.
Ministers insist we are doing better than other advanced nations – and UK growth remains quicker than most. Yet while the US has now fully recovered, with GDP 1.4pc bigger than at the end of 2019, prior to the pandemic, the UK economy remains 2.1pc smaller.
In Germany, there’s a 1.5pc GDP shortfall, falling to 1.4pc in Italy and just 0.1pc in France. In his budget statement last month, Rishi Sunak based all his sums on full-year growth projections of 6.5pc this year and 6pc in 2022. I can’t see that happening.
The UK now faces spiralling inflation and a looming growth slowdown – which will further weaken our public finances. This is not a good time for the Bank of England’s credibility to be in play.
On Monday, though, the House of Lords will debate a hard-hitting report published in July by the Economic Affairs Select Committee.
“Quantitative Easing: A Dangerous Addiction” clearly got on the nerves of the Bank of England and the Treasury. Both institutions published somewhat dismissive responses, despite the committee being stacked with some of the UK’s most influential economists, including former Bank Governor Mervyn King.
Peers argued that the UK’s QE programme – which has ballooned during this pandemic, the Bank now on course to own no less than £875bn of government debt, bought using newly-created money – poses “inflationary dangers” and risks “a loss of credibility”.
Ahead of tomorrow’s debate, I’ve spoken to several peers, united only by their economic expertise. They are alarmed – rightly – about confused Bank of England messaging.
When it comes to inflation, the vast majority of policymakers, from the US President downward, are badly behind the curve.
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