Unlock the Editor’s Digest for free
Roula Khalaf, Editor of the FT, selects her favourite stories in this weekly newsletter.
Fresh evidence of sticky inflation in the UK is likely to harden the Bank of England’s determination to keep monetary policy tighter for longer, as it seeks to squeeze persistent price pressures out of the economy.
But the data leaves the UK central bank with an increasingly difficult challenge as rising prices coincide with signs of sluggish growth: can it stamp out inflation while sparing the economy from unnecessary pain?
Headline consumer price inflation unexpectedly held firm at 6.7 per cent in September, official data showed on Wednesday, while services inflation — a gauge of domestic pricing pressures closely followed by the BoE — ticked higher.
The figures followed separate data that showed UK wage growth remained close to record highs in the three months to August.
“Inflation is higher than comparable measures in France, Germany, the US and the EU27 as a whole,” noted Ellie Henderson of Investec. “This is not an accolade the Bank of England wants to win.”
The BoE’s plan for dealing with the UK’s persistent inflation is to hold interest rates at high levels until the inflation threat has passed. The bank’s chief economist Huw Pill has labelled the strategy “Table Mountain”, an allusion to the flat-topped landmark in South Africa.
The approach is intended to prime the UK public for a long period of high borrowing costs that would durably tamp down inflation, rather than jolting the economy and potentially stoking up financial stability risks by sharply hiking rates and then reversing course with steep cuts.
Given the latest evidence of persistent inflation, many economists expect the BoE Monetary Policy Committee to hold rates at their 15-year high of 5.25 per cent at its November meeting, following a finely balanced decision to leave them unchanged at its last meeting.
But this approach remains fraught with risk. The most recent UK output numbers paint a picture of a vulnerable economy that is struggling with higher mortgage rates, rising taxes, the depletion of household savings, and higher corporate insolvencies.
GDP rose by just 0.2 per cent in August following a 0.6 per cent quarter-on-quarter fall in July. The figures mean it is unclear whether the UK will see any growth in the third quarter, according to the National Institute for Economic and Social Research.
A tough fiscal settlement in chancellor Jeremy Hunt’s November 22 Autumn Statement is set to add to the headwinds facing the economy. Hunt is expected to squeeze spending further while resisting calls from some Conservatives to cut taxes.
The UK, like other economies, faces further threats from the spectre of a widening conflict in the Middle East beyond Israel and Gaza, which would be likely to inflame oil and gas prices and trigger a fresh supply-driven inflation shock while hitting confidence.
With a general election expected next year, the independent central bank, led by governor Andrew Bailey, is set to face calls to relent and ease borrowing costs if the economy continues to deteriorate, as many analysts expect.
Sanjay Raja, economist at Deutsche Bank, said the UK economy would be “walking a fine line between recession and stagnation” in the coming months as the lagging effects of previous monetary policy tightening become increasingly apparent. Only around half of the impact of rate rises to date have so far fed through into the UK economy, according to Raja.
The BoE is not alone among central banks in finding itself on a tightrope as it seeks to reduce the risks of an economic hard landing while conquering inflation. Its task of calculating how far and hard to push tight monetary policy has been made particularly difficult by the series of shocks that have hit the UK economy in recent years — principally Brexit and global issues such as Covid-19 and the Russian invasion of Ukraine.
These have led to fundamental changes in the supply side of the economy, confounding the bank’s traditional models for economic analysis. Some of the factors may explain the higher inflation rates seen in the UK compared with its peers, according to Paul Dales of Capital Economics.
The UK has markedly higher wage growth than in the US and the eurozone, for instance, which Dales said could be driven at least in part by a post-Covid contraction in the size of the workforce that forced companies to lift pay. A less flexible immigration system post-Brexit may also be playing a part.
One option for the BoE would be to wait until conclusive evidence emerges in price or wage data that it has vanquished the UK’s inflation problem before the central bank starts cutting rates
But rate-setters are meant to be forward-looking, Pill pointed out at an event earlier this week. Waiting to see the “whites of the eyes” of declining inflation before easing risked waiting too long, he said.
The economic indicators available to the BoE have often conflicted. The jobs market has clearly loosened, a range of surveys show, but some point to a rapid weakening while others suggest only a slight easing.
Wage growth looks much stronger on official measures than other sources suggest, but the Office for National Statistics delayed the release of key data on employment and labour force participation this week because of problems with data collection.
With domestically generated inflation continuing to “run hot”, Krishna Guha of Evercore ISI said there remained a risk that the Bank “could yet find itself scrambling to tighten further”.
As Pill told his audience this week, the top of Table Mountain in South Africa is often “shrouded in cloud”, a reminder that the BoE does not have a clear view of developments in the economy. Any further shocks could easily throw its current strategy back off course.
