It’s much too early to feel triumphalist about the defeat of inflation
Andrew Bailey and his chums at the Bank of England’s monetary policy committee seem to have become newly disagreeable, at least with one another. At the September policy meeting the vote was 5-4 in favour of leaving interest rates unchanged, the sort of knife-edge decision that in recent years has been conspicuously absent. Disagreement, however, is a good thing: economics is highly uncertain and too much unanimity on the committee smacks of complacency.
At first investors appeared content to ignore the committee’s “split” — four members voted in favour of a further rate increase — preferring instead to focus on an overall decision reinforced by Bailey’s comments to the Treasury committee last month, notably his hope that inflation would “fall quite markedly” through the remainder of the year. Investors priced out further rate increases and, as such, sterling softened against the US dollar.
Compared with the Bank, the Federal Reserve was offering a more sober assessment of the monetary policy outlook: US policy rates might be close to, or even at, the peak but they were now likely to be “higher for longer”.
That messaging, in turn, contributed to a further sell-off in the world’s bond markets. At the end of last week, the benchmark US ten-year Treasury yield had risen above 4.5 per cent, up from a mere 0.5 per cent at the height of the pandemic in mid-2020 and the highest rate since 2007, which was before the onset of the global financial crisis.
Yet it was not just the Fed’s hawkish messaging that made investors nervous. Oil prices have been rising rapidly since the summer, up from about $75 per barrel to a rather more inflationary $95 per barrel today. Admittedly they are still lower than they were when the world emerged from the pandemic last year but, for central bankers relying on persistently lower commodity prices to help in the battle against inflation, recent developments in the oil market can hardly be regarded as good news.
For the UK there is an extra ingredient. Although the Bank has cast doubt on official wage data, it is still unnerving (for central bankers at least) to read that wages in the private sector are rising at an annual rate of more than 8 per cent. Given that there is little by way of productivity growth, the only sensible conclusion is that earlier inflationary shocks have caused so-called “second-round effects” that are enormously unhelpful for a central bank mandated to bring inflation back down to 2 per cent.
In the late 1980s UK policymakers faced similar dilemmas. Oil prices had tumbled, policy rates were falling and Nigel Lawson, the chancellor (who in those days was responsible for both monetary and fiscal decisions), was regarded as an all-conquering hero.
Yet those working with Lawson at the Treasury were puzzled. Inflation was unexpectedly low (threatening to drop below 3 per cent) but wage growth was stickily high (refusing to edge much below 8 per cent). The two could not coexist indefinitely. Some thought wage growth would moderate. Others, correctly as it turned out, feared that inflation would eventually re-accelerate.
For all the triumphalist headlines in recent days suggesting that inflation has been dealt a mortal blow, it is worth stepping back a bit. Bond markets are cottoning on to the idea that, even if inflation does come down, interest rates may have to stay higher simply to keep it there. Oil markets are moving in the wrong direction, suggesting that commodity-led progress on inflation earlier in the year may go into reverse. As far as the UK is concerned, underlying inflationary pressures are still remarkably high.
Inflation took a long time to reappear but now that it is here its removal is likely to prove fiendishly difficult.
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